ETF Strategy: Follow the Trend, Or Stick to the Principal?

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Includes: AGG, BIV, BND, BSV, BWX, CIU, CSJ, FXA, FXE, FXY, HYG, IEF, IEI, JNK, LQD, MBB, MUB, PVI, SHV, SHY, SPY, TFI, TIP, TLT
by: Hao Jin, CFA
The advance/decline line represents the number of advancing issues divided by the number of declining issues over a given period. A number greater than 1 is considered bullish, while a number less than 1 is considered bearish. A rising line confirms that the markets are moving higher.
Below is the NYSE advance/decline chart from LearningMarkets.com as of Aug 5.

SPDRs (NYSEARCA:SPY)’s price is over $100 again. Based on the chart above, the trend is going up (more detail explanation can be found here). Should we follow the trend, or stick to original asset allocation?
Black swan events have become common these days. Events that are meant to occur once in a millennium now seem to occur every few years. Nassim Nicholas Taleb, author of The Black Swan and former currency trader, said “ 97% of all the returns I ever made as a trader, I made on one day (Oct 19, 1987).”
In 2004 Fortune named Bear Stearns the most-admired securities firm. In 2006, Euromoney named the firm the best investment bank in North America. In his new book, House of Cards, Willian Cohan demonstrates how Bear Stearns, a company that had been a colossally profitable enterprise in the 85 years since its founding, collapsed due to risky bets in mortgage-backed securities.
Regardless how much money you made before, if there is no risk control, or sticking to principal, one mistake could wipe out all previous gains.
As a conservative investor, I slowly trim back my equity holdings to make sure they do not exceed the pre-set percentage target. Then I put money in other asset classes such as bonds, REITs, commodities or Forex. When I started buying stocks in the early '90s, I did it once a year. Since last September, I have had to re-balance my portfolio more frequently, sometimes even once a week.
The following are the top 20 bond ETFs (by net assets) I compiled from Yahoo Financial:
#
Fund Name
Ticker
1
iShares Barclays TIPS Bond
(NYSEARCA:TIP)
2
iShares iBoxx $ Invest Grade Corp Bond
(NYSEARCA:LQD)
3
iShares Barclays Aggregate Bond
(NYSEARCA:AGG)
4
iShares Barclays 1-3 Year Treasury Bond
(NYSEARCA:SHY)
5
Vanguard Total Bond Market ETF
(NYSEARCA:BND)
6
iShares iBoxx $ High Yield Corporate Bd
(NYSEARCA:HYG)
7
iShares Barclays 7-10 Year Treasury
(NYSEARCA:IEF)
8
iShares Barclays 1-3 Year Credit Bond
(NYSEARCA:CSJ)
9
iShares Barclays 20+ Year Treas Bond
(NYSEARCA:TLT)
10
iShares Barclays Short Treasury Bond
(NYSEARCA:SHV)
11
Vanguard Short-Term Bond ETF
(NYSEARCA:BSV)
12
SPDR Barclays Capital High Yield Bond
(NYSEARCA:JNK)
13
iShares Barclays MBS Bond
(NYSEARCA:MBB)
14
iShares Barclays Intermediate Credit Bd
(NYSEARCA:CIU)
15
iShares S&P National Municipal Bond
(NYSEARCA:MUB)
16
SPDR Barclays Capital Intl Treasury Bond
(NYSEARCA:BWX)
17
Vanguard Intermediate-Term Bond ETF
(NYSEARCA:BIV)
18
iShares Barclays 3-7 Year Treasury Bond
(NYSEARCA:IEI)
19
PowerShares VRDO Tax-Free Weekly
(NYSE:PVI)
20
SPDR Barclays Capital Municipal Bond
(NYSEARCA:TFI)
iShares Barclays TIPS Bond (TIP) is the #1 bond ETF. A fixed couple rate is applied to the inflation-adjusted principal so that as inflation rises, both the principal value and the interest payment increase. This can provide investors with a hedge against inflation.
Over the last 12 months, TIP’s dividend was as follows. The average price was exactly $100, which makes its annual yield of 3.6%.
07/01/09
$0.389
06/01/09
$0.371
05/01/09
$0.623
04/01/09
$0.474
10/01/08
$0.800
08/01/08
$0.934
Total
$3.591
Price of bonds, even inflation-protected bonds, may fall because of a rise in interest rates. However, TIP should be less susceptible to increases in interest rates.
It is possible that we might have deflation over a long period of time during this recession. If this occurs, the principal and income would likely decline in price, which could result in loss. Also, it still has currency risk, in case the US$ depreciates. That’s why I also make sure TIP doesn’t exceed a certain percentage of my portfolio.
By the way, the biggest currency ETF (by net assets) is no doubt CurrencyShares Euro Trust (NYSEARCA:FXE). But the 2nd biggest one is CurrencyShares Australian Dollar Trust (NYSE:FXA). Most people would think it is CurrencyShares Japanese Yen Trust (NYSE:FXY).
TIP’s price will fluctuate in accordance with changes in its NAV, as well as market supply and demand. According to its 2009 Prospectus to Shareholders, most of the time (85.6%) it was traded within a -.05% and 1% range. However, occasionally it was traded at a premium of greater than 1%, which means 1% above its NAV. Today’s TIP is traded near its NAV.
Disclose: I have a position in SPY and TIPS.