An ETF Strategy For An Uncertain Market Climate

December 7th, 2012 by Covestor
BKLN: PowerShares Exchange logo
BKLN
PowerShares Exchange

Submitted by Covestor as part of our contributors program

Bill DeShurko

We’ve been whipsawed several times this year with trades in and out of the SPDR Barclays High Yield Bond ETF (JNK). It seems to have happened again as JNK has moved solidly above its 30-day moving average. I waited a few days to see how the fiscal cliff debate would play out.

The pre-holiday announcement that both sides agreed to play nice on debt talks came as no surprise. Nor did the nice holiday week rally that it precipitated. However, there was a lingering question as to what would happen when lawmakers returned from vacation and actually started bickering. Despite what apparently was a rather rancorous debate, the markets have held together pretty well.

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As an aside, looks like the EU has kept Greece in the fold, at least for another few months. Since the U.S. stock markets haven’t broken their uptrend that started in mid-summer, it seems
the best course of action is to go “all in” and hope for the Santa Claus rally to come to fruition.

“All in” for my Covestor Dividend and Income Plus model means going from 20% cash position to a 20% position in JNK. But on further review, I could not pull the trigger on JNK. Currently JNK is yielding just 6.91%, while a good comparative yield, I think the market has gotten a bit frothy as yield hungry investors have flocked back into JNK and its cousin the iShares iBoxx $ High Yield Corporate Bond Fund (HYG), after a short pause.

At these yields I am a bit worried that high yield bonds won’t offer quite the protection I would normally expect if interest rates do pick up in the coming year. Issuing covenants are also being loosened to new issues which implies higher credit risk. My solution was to purchase the PowerShares Senior Loan Portfolio ETF (BKLN) instead.

Essentially BKLN is a “junk bond” fund like JNK, however its loan holdings are adjustable rate loans. The downside is that its current yield is lower: 4.95%. However, due to the adjustable nature of its holdings, its net asset value (NAV) should prove to be relatively stable in a rising rate environment.

After purchasing BKLN, I still had a little extra cash in the account. Instead of letting it sit idle, I picked up a few shares of McDonald’s (MCD). The fast food chain’s ex-dividend date is the 29th, and historically November is the month when they increase their dividend for the year.

I am very content with reinvesting dividends at that rate if we continue with our “muddle through” economy for 2013. At the same time, I think our holdings have significant capital appreciation potential if we get both an economic and market surprise to the upside.

The investments discussed are held in client accounts as of November 30, 2012. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.

Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.