David Fabian: As we close in on the mid-point of 2014, I am reminded of the panic that was just setting in with respect to interest rate-sensitive ETFs this time last year.
In May of 2013, the CBOE 10 Year Treasury Note Yield (TNX) hit a low of 1.65% and subsequently catapulted to over 2.4% by the end of June. That is a 50% jump in just two short months as a result of tapering rhetoric by then Federal Reserve Chairman Ben Bernanke.
Initially the thought of removing the Fed’s artificial stimulus was abhorred by income investors as the beginning of the end for asset classes such as bonds, REITs, preferred stocks, and utilities. The combination of sharply rising yields along with a bullish equity market was considered to be the perfect recipe for the “Great Rotation” from stodgy bonds to high flying stocks.
In fact, I distinctly remember clients calling me in the third quarter to 2013 to sell all of their interest rate-sensitive holdings. No one wanted anything to do with fixed-income or anything that was tied to a yield other than dividend paying equities.
Of course, investor psychology being what it is, that ended up marking a high in yields and subsequently an excellent time to enter holdings such as the iShares Investment Grade Corporate Bond Fund (NYSEARCA:LQD), Vanguard REIT ETF (NYSEARCA:VNQ), oriShares U.S. Preferred Stock ETF (NYSEARCA:PFF).
At the time those positions looked absolutely foolish in the face of investor sentiment so firmly rooted in the notion that bond yields have nowhere to go but up. However, when so many people are piled on one side of the ship, the smart money is already heading in the other direction to tip the equilibrium back to an even keel.
Flash forward a year later and we are at a completely different phase of the risk spectrum for income investors. The mood has shifted to chasing performance in these asset classes at what may be an inopportune moment to commit new capital at stretched valuations.
The historically low interest rate environment is also creating anxiety to chase yield in areas that conservative investors would normally forgo because of higher credit or structural risk.
Everyone has taken notice of the run in REITs, closed-end funds, utilities, and preferred stocks from those oversold levels and wants a piece of the action before the music stops. On a year-to-date basis, the majority of these asset classes are beating a traditional equity-income benchmark such as the iShares Select Dividend ETF (NYSEARCA:DVY). In addition, they all have higher yields than the measly 3% dividend stream you receive from DVY.