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Why These Dividend ETFs Are Downright Dangerous

Last week, the Fed released the results for the latest round of stress testing of 18 big U.S. banks.

These tests are supposed to show how low banks' capital ratios would fall under their proposed plans for dividend hikes and stock buybacks under "severely adverse" economic conditions.

The Fed approved the capital plans of 14 of the 18 banks it tested.

It conditionally approved another two, as long as they resubmit their dividend and share buyback plans to the Fed by the end of the third quarter. These were JPMorgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc. (NYSE:GS) – two of the more aggressive dividend payers.

JPMorgan Chase will hike its quarterly dividend payment 15% and spend another $6 billion on share buybacks. Goldman Sachs hasn't yet made its plan public.

Of the other 14 to get the green light, Wells Fargo & Co. (NYSE:WFC), American Express Co. (NYSE:AXP), U.S. Bancorp (NYSE:USB), Regions Financial Corporation (NYSE:RF) and Fifth Third Bancorp (NASDAQ:FITB) have already announced dividend hikes.

This is dangerous. In fact, I can almost guarantee you'll lose money if you buy them now.

As I pointed out last week, these banks haven't yet been stress-tested using the new Basel III rules – which will require them to hold more of their capital in reserves. And if they were, they wouldn't likely pass as easily as they did this time around.

But it gets worse...

Because even if you never buy another bank stock, you may still end up owning some – and suffering the consequences once Basel III gets a hold of them.

The culprit: ETFs. And more specifically, dividend ETFs.

Dividend ETFs are becoming more and more popular – especially with investors now forced to reach for yield in the stock market as a result of the Fed wiping out yields in bonds.

Take the iShares Dow Jones Select Dividend ETF (NASDAQ:DVY). This tracks the performance of the 100 highest dividend payers in the S&P 500.

DVY pays a yield of 3.4% – not great, but not too shabby either. The problem is its exposure to dividend-paying bank stocks.

Prior to the 2008 meltdown, 42.5% of DVY's holdings were in the bank stocks now under scrutiny by the Fed. (These were among best dividend-paying stocks before the housing bubble burst.)

But that changed when bank stocks started cutting their dividend payments during the financial crisis. Now, financial sector dividend payers make up just 10%.

But that's about to change, as banks get the all-clear from the Fed to hike their dividend payments again.

If you own DVY, or any other U.S. equity dividend ETFs, go to its website and check out its sector allocation. See if it is adding banks back into its portfolio. If it is, I recommend you sell it immediately.

When Basel III comes into effect in 2015, these banks will be forced to hold on to more of their capital. That means they'll have to cut their dividend payments.

Bank stocks may look attractive right now. But they are NOT a smart way to add stable income streams to your portfolio.

Avoid these temporary dividend payers and the ETFs that hold them.



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