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Stock Bubble to Burst Ahead? Quality ETFs to Play

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U.S. markets have seen a great start to 2021, thanks to a super-dovish Fed and ECB, COVID-19 vaccine rollouts and optimism about fatter fiscal stimulus in the Biden presidency. Wall Street has been hovering over record highs.

Overall, the S&P 500-based ETF (SPY - Free Report) , the Dow Jones-based ETF (DIA - Free Report)  and the Nasdaq-100 ETF (QQQ - Free Report)  have added about 4.2%, 2.5% and 6.5%, respectively, in the past one month (as of Jan 25, 2021). Emerging market ETF (EEM - Free Report) jumped about 12.2% past month while all-world ETF ACWI advanced about 5% (read: 5 Emerging Market ETFs That Gained Big on Biden Inauguration).

Is a Bubble Forming?

A huge inflow of cheap money and renewed risk-on sentiments amid the start of vaccination program, led the world stocks to add a handsome $33 trillion in value from their lows of last March, per a Reuters article.An increased number of retail investors has resulted in soaring prices. Retail broker eToro told Reuters that it recorded more than 380,000 new users in the first 11 days of 2021.

However, the euphoria is hardly making a difference between stronger and weaker. The small-cap Russell 2000 Index’s companies that have a negative operating profit topped the wider index by nearly 50 percentage points over last year, a Reuters analysis of Refinitiv data revealed.

“Pockets of the market have recently demonstrated investor behavior consistent with bubble-like sentiment," per Goldman Sachs analysts led by David Kostin, as quoted on the Reuters article. However, not all research houses are fearing a bubble.

The priciest equity indices are still running behind the performance of the previous bubbles, per Robert Buckland, Citi equity strategist, as quoted on Reuters. For example, the S&P trades at 22 times 12-month forward earnings, below the peak of 25 times seen ahead of the dotcom crisis. So, Citi expects further equity rally in the coming days.

At just over 1%, the yield on the Bloomberg Barclays Multiverse Index of 10-year government and corporate bonds worldwide is the minimum in the 22-year history of the index — less than half the rate of just two years ago and compared with 6.2% at the height of the dotcom bubble, the Reuters article noted.

Such low rates should keep equity market investing charged up. But then, a new variant of coronavirus and its worldwide outbreak is a concern. We are yet to see if vaccines are effective in the new variant of coronavirus."Hedge funds appear optimistic, but many businesses and individuals are still keeping cash on the sidelines given the uncertainty,” Morgan Stanley's cross-asset strategist Andrew Sheets told clients, per a Reuters article.

Concerns are also brewing about supplies of COVID-19 vaccines. The EU’s health chief recently stated that AstraZeneca AZN has said it “intends to supply considerably fewer doses in the coming weeks than agreed” and warned to stop exports of any vaccine from the EU.

Add Quality to Your Portfolio

In such a scenario, investors can seek safety in high-quality stocks and the related ETFs. Quality stocks are generally rich in value characteristics like strong return on equity, low earnings variability, higher free cash margins and low debt to equity.Thanks to the above-average and high-quality traits, quality ETFs may go a long way in protecting one’s portfolio in turbulent times. Below we highlight a few quality ETFs that are poised to be on investors’ radar.

ETF Picks

SPDR MSCI USA StrategicFactors ETF (QUS - Free Report)

The underlying MSCI USA Factor Mix A-Series Index measures the equity market performance of large and mid-cap companies across the U.S. equity market. It aims to represent the performance of a combination of three factors: value, quality and low volatility. The fund has a Zacks Rank #3 (Hold) (read: Here's Why Quality ETFs Are Looking Attractive Now).

VanEck Vectors Morningstar Wide Moat ETF (MOAT - Free Report)

The fund follows an index which tracks the overall performance of the “attractively priced companies with sustainable competitive advantages.” As a result, this fund also calls for quality exposure.

iShares Edge MSCI USA Quality Factor (QUAL - Free Report)

The fund looks to follow large- and mid-cap U.S. stocks displaying positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage). It charges 15 bps in fees.

FlexShares Quality Dividend ETF (QDF - Free Report)

The underlying Northern Trust Quality Dividend Index is designed to provide exposure to a high-quality income-oriented portfolio of long-only U.S. equity securities, with emphasis on long-term capital growth and a targeted overall beta that is similar to that of the Northern Trust 1250 Index and the stocks are selected based on expected dividend payment and fundamental factors. It charges 37 bps in fees and yields 2.30% annually.

Invesco SP 500 Quality ETF (SPHQ - Free Report)

The underlying S&P 500 Quality Index tracks the performance of stocks in the S&P 500 Index that have the highest quality score, which is calculated on three fundamental measures — return on equity, accruals ratio and financial leverage ratio. The fund charges 15 bps in fees.

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