Treasury Bond ETFs Are Neither Confirming Extended Stock Pullback Nor Serving As Safer Havens

Includes: IEF, TLT
by: Gary Gordon

On an intra-day basis through Thursday (10/25), the Dow had pulled back 4.6% from a 52-week high. Similarly, since tagging a multi-year, intra-day peak, the S&P 500 had forfeited 4.8%.

Is the presence of corrective activity and consolidation alarming? Hardly. The fact that investors were able to ignore earnings and revenue warnings until those admonitions became actualities is far more surprising.

We shouldn’t blame profit and sales weakness alone, however. There is a real possibility of a disputed outcome in the upcoming election — in the White House as well as control of the Senate. The stakes couldn’t be much higher.

How might this affect riskier assets? Bush v. Gore ugliness resulted in -8% returns for large-cap equities in November of 2000. Of course, at that time, unemployment was not widespread, the Federal Reserve was not purchasing treasury/mortgage-backed bonds, and a fiscal cliff catastrophe was not looming on the immediate horizon.

While there are some who are talking about the chance of a post-election scramble in 2012, the markets may be thinking in terms of a highly probable post-election scrum. That causes risk takers to take a wait-and-see approach.

The reason that markets are beginning to consider a likely dispute has to do with new voting laws. New “provisional ballot” rules in swing states like Virginia, Florida, Ohio and Wisconsin haven’t been previously tested. And when scores of additional voters cast provisional ballots, officials must scrutinize those ballots to determine which should count and which may be deemed duplicates. (Can you say, “hanging chad?”)

Before the first week of October, markets believed that Obama would win the presidency, and that the House of Representatives would go to the Republican party. A split between the legislative and executive branches has often been beneficial to stocks. Today, with the candidates neck-and-neck, the White House may not be determined until Thanksgiving. What’s more, a 50-50 split in the Senate would effectively go to the Republican party if Romney prevails, making tight Senate races all the more contentious. Again, provisional ballots may play a role in determining the make-up of the Senate.

Clearly, weeks of not being able to recognize who controls what causes more than heartburn and indigestion for institutional and individual investors. One can choose to buy volatile dips on the notion that winners will be declared eventually. However, the ripple effect of not being able to know the landscape is the inability to assess the economic impact of a non-negotiated fiscal cliff calamity (e.g., rising payroll taxes for all employees, capital gains tax increases, absence of an alternative minimum tax patch, dividends reverting to ordinary income, automatic cuts to the defense sector, etc.).

Nevertheless, there are signs that the fears may be temporary. “Risk off” flight-to-safety investing over the last five years has often seen Treasury Bond ETFs gain at the expense of Stock ETFs. In the last month, however, U.S. Treasury Bond ETFs have struggled in the same manner as Stock ETFs.

(click images to enlarge)

In spite of genuinely weak corporate sales… in spite of a Federal Reserve’s commitment to suppress interest rates… in spite of an intra-day corrective phase that approached -5%… and in spite of a highly probable post-election dispute… participants have yet to flock to Treasury Bond ETFs. The absence of panicky treasury bond buying is one reason to believe that stocks may yet find support levels to build upon.

Disclosure: 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.