Recent economic data on the domestic front bears testimony to the fact that the U.S. economy is well and truly treading on the path to recovery.
Retail sales and consumer confidence have been on the rise, more jobs are being created, there has been an impressive recovery in the housing market and the growth is finally expected to overtake the “muddle through” trend. (Read Is This a Bull Market for Retail ETFs?).
However, despite all these signs of resurgence, it can still be argued whether these developments (i.e. fundamentals) really justify the current levels of U.S. equities (sentiments). Of course, needless to say, any discrepancy between the two can be attributed to the Federal Reserve and its monetary easing program. The equation, therefore, is simple; Sentiments – Fundamentals = The Fed.
Nevertheless, with improving fundamentals, there is no doubt that the ‘difference’ has been diminishing of late. With that being said, the investors cannot afford to be complacent yet.
While the broader picture of the market hints at the bullish trend to continue, the possibility of a ‘healthy’ correction cannot be ruled out. In the light of the above state of affairs, let us have a look at some ETF strategies that, in our view have high chances of outperforming the broader markets in the long term.
Precious Metal Focus: i) A rise in Inflation is long Overdue ii) A safe haven play
The Federal Reserve’s balance sheet has increased by gigantic proportions over time, thanks to its monetary easing measures. With the amount of ‘new money’ created and circulated in the economy, inflation is bound to increase sometime in future, though that clearly has not happened as yet.
Nevertheless, the Federal Reserve seems pretty determined to continue its money printing spree until the threshold of unemployment level of 6.5% is met, provided inflation stays below 2.5%. Although inflation should have increased with the quantum of monetary easing in the economy, yet, thus far, it has remained rather subdued. (See Have We Seen the Bottom in Gold ETFs?)
Also, with a correction for the equity markets well and truly on the cards, precious metals, particularly gold will be in focus. With that being said, its white counterpart—silver should not be ignored either.
The white metal is known to exhibit characteristics of both precious metals as well as equities. (see Silver--The Equity Like Precious Metal ETF?) This makes an interesting case for investments in silver as a rise in inflation will surely pick silver prices up, thanks to its vast industrial usage.
In fact, the biggest and most popular ETFs from the precious metal space, the SPDR Gold ETF (GLD - ETF report) and the iShares Silver ETF (SLV - ETF report) are ‘Buy’ rated. GLD has a Zacks ETF Rank of 2 or ‘Buy’ whereas SLV has a Zacks ETF Rank of 1 or ‘Strong Buy’. Therefore, we expect both these ETFs to do well in the coming months.
Current Income Focus: Emerging Market Bond ETFs offer a good play.
It is a very well known fact that the Federal Reserve’s low interest rate policy has for long plagued investors seeking current income. Furthermore, investment avenues that were for long considered to be safe havens like the Treasury Bond ETFs, have little room for further appreciation.
This is primarily due to the fact that the long-term treasury yields have very little scope for a further slide. As a result, from a total return perspective, Treasury Bond ETFs in the form of current interest income and capital appreciation are rather limited. (Read Treasury Bond ETFs: Still Room to Run?) At present emerging market bond ETFs offer better value than the developed market bonds funds, primarily due to two specific reasons.
Firstly, the currencies of developed economies like the Euro and the Japanese Yen have been depreciating versus the U.S. dollar due to their ongoing domestic woes and large scale central bank monetary easing. Therefore, the currency effect is most likely to understate returns from the developed market bond ETFs, more than the emerging market funds.
Secondly, emerging market funds have a higher interest rate attached to them than most developed market funds. Therefore, from the current income point of view, the emerging market bond funds are better placed than their developed market counterparts (Read 3 ETFs Beating the S&P 500).
Further due to the high interest rate scenarios in the emerging economies the possibility of a rate cuts is far more in the developing nation than the developed ones. This also makes an attractive investment case for emerging market bond ETFs.
For the more aggressive investors, local currency denominated sovereign bond ETFs are suitable options.. In this case, the WisdomTree Emerging Markets Local Debt ETF (ELD - ETF report) is a popular alternative. However, for investors seeking to hedge the currency effect completely, the U.S. dollar denominated ETF, iShares J. P. Morgan USD Emerging Markets Bond ETF (EMB - ETF report) is a good option that is worth considering.
Low Risk ETFs: Does Not Always Mean Lower Return
We have mentioned in our previous articles that low risk does not necessarily mean low return. (See Buy These ETFs for Higher Returns and Lower Risk). This is especially with regard to the longer term picture. However, it is very important for investors to consider the fact that this particular strategy is most likely to underperform the broader markets in a momentum based rally.
This is primarily because they possess subdued volatility characteristics like a low beta value or low annualized standard deviation compared with their ‘higher risk’ counterparts.
However, over the long term, low risk plays prove to be a winning bet, especially taking into account the investors’ risk tolerance as measured by their risk adjusted returns. With all that being said, it is once again imperative to consider the fact that a broader market correction is long overdue.
In this regard, low risk investing will once again be the focus of the investors’ attention to ride out the market volatility as and when the pullback takes place. Two U.S. focused low volatility ETFs that investors should consider are the PowerShares S&P 500 Low Volatility ETF (SPLV - ETF report) and the iShares MSCI USA Minimum Volatility ETF (USMV - ETF report). SPLV has a Zacks ETF Rank of 1 or ‘Strong Buy’ with a ‘Low’ risk outlook.
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