Investors Pour Money Into Long-Bond ETFs

There is no shortage of disappointing news during this festive season, and this is reflected in our top-rated ETFs for November. We have seen a flight to quality, driven by risk aversion, into such securities as U.S. Treasuries and, to a lesser extent, municipals.

The most highly rated ETFs were dominated by foreign funds as recently as early 2008 and leveraged short funds just a few months ago. That has completely changed. The uncertainty of the depth of this downturn gives little transparency for 2009 company earnings. This, in turn, has affected the perception of risk in the marketplace, leading to one of the most powerful of emotions, fear, dictating investment decisions.

There may be undervalued stocks out there, but all bets are off until some form of order is restored to the financial system. Despite massive government spending, there need to be signs that unemployment is stabilizing. We now have a vicious cycle that is feeding on itself and likely to get worse with further "shoes to drop" in the new year, such as increased defaults in construction loans and credit cards, the possibility that falling commodity prices will trigger collapses in the farming sector, taking rural banks with them, and the ever-present danger for the stock market of hedge-fund repatriations, especially in the light of the alleged Madoff fraud.

This month's list shows that the flight to U.S. government securities has been across maturities, ranging from three- to seven-year issues via the iShares Lehman 3-7 Year Treasury Bond Fund (IEI) to 10- to 20-year bonds via the iShares Lehman 10-20 Year Treasury Bond Fund (TLH). Note that the shorter-term securities have already experienced considerable price appreciation this year and, hence, investors have started to bid up the prices of longer-dated securities, leading to the 11.89% return for TLH in November, as opposed to the 3.68% return for shorter-dated issues. This has resulted in a flattening of the yield curve.

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