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ETFs Handling the 'Taper Time' Pressure


NEW YORK ( ETF Expert) -- On Thursday, the 10-year yield broke through the psychological barrier of 2.75%. Since May, the intermediate-term 10-year Treasury has catapulted from a year-to-date low near 1.6% to a year-to-date high of 2.8%.

Clearly, the U.S. Federal Reserve is having trouble persuading investors that -- absent its $85-billion-per-month bond binge -- they have the tools to suppress longer-term interest rates.

Perhaps ironically, if the Fed announces any tapering of its quantitative easing (QE) program in September, many project that it will be a modest move from $85 billion to $75 billion. Think about that for a moment. Bernanke's central bank may or may not slow the purchasing of U.S. Treasuries as well as mortgage-backed securities. What's more, should the Fed do so, it will be an exceptionally modest reduction. Yet, the 10-year yield has rocketed 75% higher (120 basis points) from 1.6% to 2.8% -- in advance of the Fed and in spite of them.

The media have dubbed the speculative exodus from bonds "front-running" the Federal Reserve. Specifically, investors do not wait around for what they perceive as a foregone conclusion; better to get out before the central bank of the United States exits QE and before the demand for U.S. Treasury bonds dissipates.

The U.S. stock market via the S&P 500 SPDR Trust (SPY) has experienced a few hiccups with the prospect of losing QE stimulus. However, SPY has been far more resilient than the vast majority of rate-sensitive income producers -- preferred shares, munis, high-yield bonds, longer-term corporates, dividend stocks, REITs, utilities as well as Treasuries.

That said, by investigating the reaction of income producers to Thursday's surge in the 10-year yield, we're able to gauge which income ETFs might stand up to the kitchen's heat.

Income-Oriented ETFs On “Taper Talk” Thursday
Approx 8/15 % 3 Mth %
Handles The Kitchen Heat
iShares S&P/Citi International Bond (IGOV) 0.8% 1.0%
PowerShares International Corporate Bond (PICB) 0.2% -0.8%
Market Vectors Investment Grade Floating Rate (FLTR) 0.1% 0.2%
PowerShares Senior Bank Loan (BKLN) -0.1% -0.7%
UBS E-TRACS Alerian MLP (MLPI) -0.2% -0.3%
Struggling To Handle The Heat
PowerShares National Muni Bond (PZA) -0.3% -9.9%
iShares Investment Grade Corporate Bond (LQD) -0.6% -6.0%
iShares S&P Preferred (PFF) -0.9% -6.6%
Vanguard Long Term Bond (BLV) -1.0% -10.4%
Vanguard REIT (VNQ) -1.8% -13.6%

The first item that stands out is the difference between real estate investment trusts via VNQ and pipeline partnerships via MLPI. The structure of partnerships as well as the structure of real estate trusts are similar in that they both exemplify tax-favored entities. REITs don't have to pay corporate taxes as long as they distribute 90% of their income, while MLPs do not have to pay federal taxes when all earnings go to unit holders.

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