Muni ETFs, Dividend ETFs For When The Fed Smoke Clears

In a recent article at WSJ.com , Jon Hilsenrath posed several hypothetical questions concerning the Federal Reserve as well as the U.S economy. As I read the piece, I found myself answering each query aloud. Later, I decided to chronicle some of the those thoughts in digital ink.

Hilsenrath asked, “Might the prospect of withdrawing stimulus undermine the recovery the Fed has been struggling for years to engineer?” This question assumes that there has been a recovery to undermine. Granted, it is true that the Federal Reserve’s policy of manipulating interest rates has allowed individuals and companies to benefit from borrowing cheaply. Yet economic growth has been anemic outside of rate-sensitive areas such as real estate, auto and debt restructuring. It follows that the possibility of the Fed slowing down its program of purchasing government/quasi-government bonds has been enough to send interest rates skyward. In essence, the prospect of withdrawing stimulus is already undermining economic expansion because that stimulus is why we have any economic improvement to date.

The author also wonders, “Are the economy and the markets healthy enough to stand on their own?” Not if consumers find themselves priced out of homes and/or vehicles. And if companies as well as municipalities need to pay more to service their debt, there won’t be as much money for new hires. In truth, corporations aren’t particularly keen on hiring anyway; going forward, central bank policy is far too murky.

As for the markets ability to deal with less stimulus, risk-takers began abandoning ship the moment Mr. Bernanke discussed “tapering” on May 22. The iShares DJ Real Estate Fund (IYR) was particularly hard hit, as were nearly every type of real estate investment trust asset. In fact, rate-sensitive assets from high yield bonds to preferred stocks to munis to utilities have endured a great deal of pain in a very brief period.

At this point, even broad market index funds like the SPDR Dow Jones Industrials (DIA) has failed to maintain support above a near-term, 50-day moving average. While that may not seem like a big deal in the context of the year-to-date gains, it is a humongous deal for those who wish to keep unrealized profits. Volatility is likely to remain elevated until Bernanke decides to remove “if-then” from Fed policy altogether. “If the economy improves, then we will taper” and “If the economy does not improve, then we will keep buying bonds in the same amount at the same pace” have added uncertainty, not clarity.

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While nobody can predict the future, we can anticipate the following: (a) China’s dual dilemma (i.e., manufacturing slowdown, bad loans in banking) will drag on the revenue of global corporations, (b) multinational companies will provide little evidence of earnings or revenue growth for the 2nd quarter, and (c) few investors will celebrate reasonable stock valuations until the Fed acknowledges that it is stuck with its previous commitment of $85 billion per month for an extended period of time.

I don’t view my outlook or expectations as bearish… on the contrary. I believe in the value of health-restoring corrections, where volatile price movement and anxiety-provoking moments provide opportunity. Let’s put it this way… you’re going to get a chance to buy lower.

Not everyone’s going to jump at the opportunity to buy dips. Similarly, not every dip is a buying opportunity. An exchange-traded fund enthusiast will need to choose his/her spots wisely. Equally important, he/she will need to select from a “personal wish list” of ETF possibilities.

For taxable accounts, Muni ETFs may be a surprising place to find value. The iShares National AMT-Free Muni (MUB) is trading at a 3% discount to its underlying net asset value. Eventually, the discount-premium will return to parity; better yet, if you believe that the 10-year yield is likely to be lower than 2.55% by year’s end, MUB will provide desirable tax-free income through year’s end.

As for stock ETFs, my song remains the same. I prefer defensive equities with less rate sensitivity. High atop that personal wish list are funds like: (1) iShares High Dividend Equity (HDV), (2) Market Vectors Retail (RTH) and (3) iShares DJ Health Provider (IHF), and (4) PowerShares Dividend Achievers (PEY).

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.

Written By: Pacific Park Financial Inc.