The stock market has been pretty volatile lately as investors awoke to the realization that the Fed will ultimately ‘taper’ its QE program. Bond yields have surged and many international markets have tumbled as markets tried to guess the Fed’s next move.
The Fed’s statement after its Wednesday meeting and chairman Bernanke’s press conference will hopefully provide some clarity regarding the future direction of the monetary policy. While it is quite unlikely that the Fed will actually dial down its bond purchases until the economic prospects pick up significantly, financial markets price in what they expect the Fed do in the future and not what the Fed is doing now.
Inventors should remember that market moves are often sudden as the sentiments change and though the long-term bullish trend for stocks appears to be intact for now, this may the right time for investors to position their ETF portfolios for an eventual tapering of the Fed’s unprecedented support and pickup in economic growth.
Buy Growth Sector ETFs as the Economy Improves
Defensive sectors outperformed the broader market earlier this year but since last month,cyclical sectors have started surging ahead. As the economy shows further signs of improvement, more and more investors will move out of defensive sectors like utilities and consumer staples and into cyclical sectors like technology and industrials. (Read: 3 Impressive Biotech ETFs Crushing the Market)
Dividend ETFs that were concentrated in defensive sectors—typically high dividend payers-- have also come under pressure. These ETFs had become somewhat expensive as investors continue to pour money into them the search of yield. While we still like dividends paying stocks and ETFs, the next winners in dividend ETFs will most likely be those focused on relatively attractively valued, high-growth cyclical sectors.
Technology and Finance companies have been dividend growth leaders in the last few years. Technology companies currently have a lot of cash on their balance sheets and will continue to generate large amounts of cash going forward too. Finance companies have also been on the mend and many of them got Fed approval to raise dividend after passing stress tests. (Read: Buy these ETFs for Excellent Dividend Growth)
Investor should consider Vanguard Financial ETF (VFH - ETF report), WisdomTree U.S. Dividend Growth ETF (DGRW - ETF report), Vanguard Information Technology ETF (VGT - ETF report) and Industrial Select Sector SPDR Fund (XLI - ETF report).
Prepare for the Rise in Interest Rates
Due to concerns about the Fed finally scaling down its asset purchases, interest rates have been going up in the past three weeks. 10 year treasury yield touched 2.29% on June 11, the highest since April 2012. (Read: Forget Dividend ETFs; Focus on Buybacks instead)
Even though the tapering announcement from the Fed may not come in the next couple of meetings, the rates will likely continue to creep up. Thus, it may be a good idea to get rid of all long duration products in your portfolio, as they will be hurt the most in a rising interest rate environment.
Remember very short-term rates will stay low as long as the Fed maintains the fed funds at near zero levels--most likely till the second half of 2015, but the long-term interest rates will begin moving up as soon as market anticipates any likely change in the Fed’s monetary policy.
Investors could consider switching to shorter duration products or products that provide protection against interest rate rise. Floating Rate ETFs like iShares Floating Rate Note Fund (FLOT - ETF report) and SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN) have become increasingly popular with investors of late.
Investors should also look at Senior Loan ETFs like PowerShares Senior Loan Portfolio (BKLN - ETF report) and SPDR Blackstone / GSO Senior Loan ETF (SRLN - ETF report) that provide high yields and protection against the potential rise in interest rates.
Some Emerging Markets Look More Vulnerable than Others
Many international markets, in particular some of the popular emerging markets have tumbled in the last few weeks. Prospects of an economic recovery and higher interest rates in the US have led to the change in investor sentiment towards global markets.
Some of the emerging markets ETFs that had seen huge investor interest in recent months like Philippines (EPHE) , Indonesia (EIDO) and Thailand (THD) saw the worst sell-off. On the other some smaller emerging markets/frontier markets avoided the crash.
While the sell-off may not be over for now, it is unlikely to continue for a long time. In fact some markets have already started attracting some bargain investors. Emerging markers still have much better growth prospects than developed markets in the longer term. At the same time, some emerging markets look more vulnerable than others.
Emerging nations that are dependent to a large extent on commodity exports like Russia (ERUS - ETF report), Brazil (EWZ - ETF report), and Chile (ECH - ETF report) are at greater risk due to the slowdown in China and a rising US dollar.
Also the countries that are going through a period of political, social and economic uncertainty—like Turkey (TUR - ETF report), South Africa (EZA - ETF report) and Egypt (EGPT) ---should be avoided even if they look attractive on valuation basis.
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