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This Nasty ETF Indicator Is Flashing AgainBy
Tuesday, July 27, 2010
In early 2007, investors were reading news stories about hundreds of new ethanol plants... enormous demand for grain in China... and rice shortages in Thailand.
Potash and farm-equipment stocks were soaring. The world's most widely published investment gurus – like Jim Rogers and Marc Faber – were touting agriculture and farmland as their favorite investments.
In short, agriculture was quickly becoming one of the most sought-after new investments in America. But you couldn't speculate directly on agriculture unless you had a futures account.
Wall Street stepped in and issued new exchange-traded funds (ETFs) to fill the gap in the market and supply investors with the "one-click" agriculture investments they were demanding. Between September 2007 and January 2008, six new agriculture ETFs launched...
In late February 2008, the agriculture bubble popped. Nine months later, these ETFs were down an average 45%.
The same thing happened with commodity ETFs just before the commodity bubble popped in 2008. It happened with short-selling ETFs just as the stock market was about to bounce in 2009. And it happened with currency ETFs just as the dollar was about to soar.
Wall Street lives on the fees it generates selling investments to the public. When the retail public falls in love with an investment idea, Wall Street cranks out products it can sell them. The more popular the investment, the more products Wall Street creates.
Whenever you see Wall Street creating lots of new investment products to sell to the public – especially ETFs – you know investors must love the idea... and prices might be forming a bubble. You should be extremely wary of buying or holding stocks in these sectors. Chances are, they're about to enter a severe correction.
So what's the hottest new ETF sector right now? It's master limited partnerships...
A master limited partnership (MLP) is a special business structure available to a small number of firms trading on the stock market. Right now, there are 91 companies in the sector. MLPs treat their shareholders as partners in a business instead of owners of a corporation. This way, they avoid corporate tax. Many different businesses can qualify for MLP status... including real estate businesses, shipping lines, and money-management businesses. But the biggest companies in the MLP sector are all pipeline businesses.
Master limited partnerships are safe, recession-proof businesses that generate stable earnings and pay high dividend yields. These characteristics make them very popular with investors... especially right now when everyone's looking for safe income stocks.
Over the last year, the money-management industry has obliged investors by introducing four new ETFs focused on MLPs, including a double-long MLP fund. This month, two more firms filed papers to float new ETF products, which will bring the total to six.
The fact that Wall Street has introduced so many MLP investments is a huge warning sign that the MLP sector has become too popular and could be about to enter a correction. I prefer to buy MLPs when they yield over 10%. Right now they yield 6% on average.
So even though MLPs are one of my favorite income investments, I recommend you avoid the MLP sector for now... and focus on safer, less popular income investments like preferred stocks and safe stocks that relentlessly raise their dividends.
If you own MLPs, don't sell them now. The industry is in such a strong uptrend, MLPs could easily rise another 25% to 50% from here. But I recommend you use a trailing stop loss. In my newsletter, we're using a 15% trailing stop loss. This way, we'll capture any additional upside, without risking the profits we've made so far.
Good investing,
Tom
Further Reading:
If you're holding MLPs right now, don't miss Tom's Saturday essay. You'll find his quick summary of the best way to trade these cyclical income stocks here: The Potential Bomb Hiding in Your Safe Income Portfolio.
DailyWealth Editor in Chief Brian Hunt used the "ETF indicator" to predict the bust in "ag" stocks in summer 2007... and the market's big bounce in early 2009. "Because this new indicator is triggered by investor sentiment and hype," he wrote, "it will surely continue to work for decades to come. Fear and greed are timeless." Get more details on how to use this indicator to spot a coming disaster here: You'll Lose Every Single Time if You Buy These ETFs.
Market NotesTHE GREAT CIGARETTE DIVIDEND MACHINE HEADS HIGHER Last week, we heaped abuse on the "perfectly hedged" clean energy fund. This kind of investment somehow manages to lose money in both good times and bad.
This week, we take a look at the antidote to faddish ideas like solar and wind energy: We look at the past year's price action in Altria (MO).
Altria is the world's dominant cigarette maker. It's a stock Dan Ferris and Tom Dyson have written bullishly about in DailyWealth (check out their arguments here and here). While it's easy to understand Marlboro's incredible brand power, most people don't understand the government loves it when folks buy Altria cigarettes. The government is even more addicted to the huge taxes it collects from Altria than Altria's customers are addicted to its product.
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