Using Market Signals To Get An Overbought ETF At A Better Price

Includes: LQD, PFF, PFXF, REM
by: Gary Gordon

The more that investors get discouraged by low-yielding treasuries, the more that they’ve chased assets that are further along the risk ladder. For example, one month earlier, iShares Investment Grade Corporate Bond (NYSEARCA:LQD) had a trailing 12-month yield of 4.1%. After a month-long surge in buying activity, however, LQD is yielding closer to 3.9%.

Granted, 3.9% may still be an attractive yield to income enthusiasts. Nevertheless, when an ETF goes on a vertical trek that puts it into overbought territory by several measures (e.g., RSI above 70, deviation above a key trendline, etc.), the asset is likely to cool off.

Let the air deflate from LQD’s balloon a bit before acquiring additional shares. A period of flattening out or depreciation of 2%-2.5% would do the trick.

LQD 1 month

Yield-hungry investors have been equally cavalier about pursuing preferred stock shares. Unlike common stock, preferreds pay fixed dividends that will not fluctuate. They are the ”hybrid cars” in the investment world – paying a fixed rate of return like a bond instrument and having capital appreciation potential like common stock.

The big problem with preferreds? Roughly 3/4 of them are issued by the financial sector. It follows that concerns about the global financial system have made this asset class far more volatile than in years prior to 2008. The chart below shows just how quickly investors abandoned iShares S&P U.S. Preferred (NYSEARCA:PFF) in May-June, and how enamoured others became in the dividend days of June-July.

PFF 50-day

Here, I have two suggestions for the yield-famished. You might choose to wait for an inevitable “risk-off” period where concerns about European countries or European banks cause profit-taking in PFF. Or you might consider the newly launched Market Vectors Preferred Excluding Financials Portfolio (NYSEARCA:PFXF). The latter may take some of the volatility sting out of preferred share investing, but may also present a less attractive annual yield.

Finally, we have one of the most successful asset classes in 2012… Mortgage REITs. These companies borrow money at ultra-low short-term rates, then invest in mortgage-backed securities; they profit from the spread between their borrowing rate and the mortgage-backed security rate. As long as the spread remains favorable, “mREITs” tend to do well. In fact, according to the folks at Blackrock, iShares FTSE NAREIT Mortgage REIT (NYSEARCA:REM) has a 30-day SEC yield north of 12.5%!

Of course, they’re hardly immune to worldwide financial shocks. Back in 2008, iShares FTSE NAREIT Mortgage REIT (REM) lost nearly 1/2 of its worth.

REM 50-Day

Many would argue, however, that Europe’s crisis does not involve subprime/Alt-A mortgage-backed securities and that toxic sovereign debt is a different creature entirely. That may be true… yet I’d still tell most investors to wait for REM to pull back to its 50-day. And after making a purchase, be sure that you understand precisely what it takes to protect yourself if the investment turns sour.

Disclosure Statement: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

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