EC Stock ETF Investors Should Track Junk Bond ETF Apathy

Perhaps as long as China is cutting rates and Europe is buying asset-backed securities – and as long as the U.S. maintains its policy of zero percent interest rates – investors can ignore traditional risk in stock assets. Then again, contrarian assessments suggest that participants are closing in on euphoric extremes and credit spreads are beginning to widen again.

Consider the preference investors have shown for investment grade government debt over comparable high-yielding corporate bonds. While spreads hit a peak at the bottom of the mid-October stock correction, they stabilized near early October levels. Lately, they’ve been creeping higher. This is easily visualized in the iShares 7-10 Year Treasury (IEF):SPDR Barclay High Yield Bond (JNK) price ratio below.

Still another way of investigating investor appetite for risk is to look at the 30-year U.S. Treasury yield. When stocks rapidly corrected from the mid-September stock highs (9/18) to the mid-October stock lows (10/16), the S&P 500 fell 9.8% on an intra-day basis. The heralded benchmark has since gone on to set all-time records. In complete contrast, the 30-year yield approximated 3.35% at the September stock peak. With stocks recovering all of their correction losses – with investor surveys expressing remarkably high levels of bullish, “risk-on” optimism – why have bond yields failed to revisit the levels that they had previously occupied? On the contrary. The 30-year yield has settled in around 3.03% for an entire month – 30 basis points lower than before the October swoon.

In truth, long-term Treasuries have been a success story throughout 2014. Better yet, those who recognized the premises behind my year-long call for falling rates benefited handsomely with funds such as Vanguard Extended Duration (EDV) and/or Pimco 20+ Zero Coupon (ZROZ). It is not that I have been wearing a bearish equity cap; rather, I proposed a barbell approach that combined long-dated Treasury ETFs on the left and larger-capitalization stock ETFs on the right, including iShares USA Minimum Volatility (USMV), SPDR Select Health Care (XLV) and iShares S&P 100 (OEF). I had been less inclined to load up on assets along the “handle of the barbell” such as high-yield bonds. The risk-adjusted performance of the approach is self-evident.


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