Wall Street has seen an upbeat start to 2023 with strong gains across major market segments and sectors. Easing inflation, hopes of the Fed’s slower rate hike path and a reopening in China have led to risk-on trade.
The latest comment from Federal Reserve Chair Jerome Powell that inflation has started easing has also bolstered investors’ confidence and spurred bets that the central bank could continue slowing its interest rate hike campaign. At the latest meeting last week, the Fed lifted its benchmark interest rate by 0.25 percentage points to 4.5-4.75% and signaled that it could be closer to pausing its rate hike plan.
Additionally, many economic data points suggest that the economy is resilient and is backed by strong job growth, rising consumer spending and excess savings accumulated during the COVID-19 pandemic.
However, recession worries continued to weigh on investors’ mind, making them cautious about their investments. This is especially true as the yield curve has inverted (in which short rates are higher than longer rates) deeply since early 1980s, triggering fresh worries about economic troubles. Notably, inversions tend to precede a recession. The International Monetary Fund warned that a third of the global economy would be in a recession this year as the United States, European Union and China will see their economies slow down (read: Invest in Defensive ETFs as Recession Fear Grows in 2023).
Further, the earnings picture so far appears to be weak and points to a recession. Earnings from the S&P 500 companies that have reported results so far are down 6.7% from the same period last year on 5.7% higher revenues, with 71.0% beating EPS estimates and 69.0% beating revenue estimates. The growth pace for both earnings and revenues represents a notable deceleration from the trend seen in other recent periods. Overall, Q4 earnings are expected to decline 5.8% followed by an expected decline of 7.5% in the first quarter of 2023.
The combination of factors has prompted investors to re-access their portfolio, leading to higher demand for lower-risk securities. As a result, we have highlighted five such zones and their popular ETFs where investors could stash their money amid the current turbulence:
Low Volatility – iShares Edge MSCI Min Vol USA ETF USMV
Low-volatility ETFs have the potential to outpace the broader market in an uncertain market environment, providing significant protection to the portfolio. This is because these funds include more stable stocks that have experienced the least price movement in their portfolio. Further, these allocate more to the defensive sectors that usually have a higher distribution yield than the broader markets.
While there are several options, USMV, with AUM of $30.4 billion and an average daily volume of 3 million shares, is the most popular ETF. The fund charges 15 bps in annual fees and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: 5 Winning ETF Ideas for Your Portfolio in 2023).
Quality – iShares Edge MSCI USA Quality Factor ETF QUAL
Quality stocks are rich in value characteristics with a healthy balance sheet, high return on capital, low volatility, elevated margins, and a track of stable or rising sales and earnings growth. These products thus reduce volatility when compared to plain vanilla funds and hold up rather well during market swings.
With AUM of $19 billion, this fund provides exposure to large and mid-cap stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index and holds 124 stocks in its basket. The ETF charges 15 bps in annual fees and trades in an average daily volume of 989,000 shares.
Value – Vanguard Value ETF VTV
Value stocks have proven to be outperformers over the long term and are less susceptible to trending markets. These stocks have strong fundamentals — earnings, dividends, book value and cash flow — that trade below their intrinsic value and are undervalued. These have the potential to deliver higher returns and exhibit lower volatility compared with their growth and blend counterparts.
This fund targets the value segment of the broad U.S. stock market and follows the CRSP US Large Cap Value Index. It holds 338 stocks in its basket with AUM of $105.6 billion and charges 4 bps in annual fees. The ETF trades in volume of 2.8 million shares per day on average and has a Zacks ETF Rank #1 (Strong Buy) with a Medium risk outlook.
Defensive – Invesco Defensive Equity ETF DEF
The defensive sectors like healthcare, consumer staples and utilities generally act as a safe haven during political and economic turmoil. Stocks in these sectors generally provide higher returns in troubles times.
Invesco Defensive Equity ETF offers exposure to companies that are principally engaged in manufacturing, selling or distributing food and beverage products, agricultural products and products related to developing new food technologies. It has amassed $264.8 million in its asset base and saw a lower volume of 19,000 shares per day, on average. DEF charges 55 bps of fees per year and has a Zacks ETF Rank #3 with a Medium risk outlook.
Dividend – Vanguard Dividend Appreciation ETF VIG
The dividend-paying securities are the major sources of consistent income for investors, when returns from the equity market are at risk. This is especially true as these stocks offer the best of both these worlds — safety in the form of payouts and stability in the form of mature companies that are less volatile to large swings in stock prices. The companies that offer dividends generally act as a hedge against economic uncertainty and provide downside protection by offering outsized payouts or sizable yields on a regular basis.
While the dividend space has been crowded, ETFs with stocks having a strong history of dividend growth like VIG seem to be good picks. The ETF has AUM of $66.4 billion and trades in volume of 2 million shares a day on average. It charges 6 bps in annual fees and has a Zacks ETF Rank #1 with a Medium risk outlook (read: Winning Dividend ETFs to Start 2023).
These products could be worthwhile for low risk tolerant investors and have the potential to outperform the broad market, especially if global growth fears continue to dampen sentiments.
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Vanguard Dividend Appreciation ETF (VIG): ETF Research Reports
Vanguard Value ETF (VTV): ETF Research Reports
iShares MSCI USA Quality Factor ETF (QUAL): ETF Research Reports
iShares MSCI USA Min Vol Factor ETF (USMV): ETF Research Reports
Invesco Defensive Equity ETF (DEF): ETF Research Reports
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