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ETF Strategies to Trade the "Sell in May and Go Away" Adage

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The old adage “Sell in May and Go Away,” which says that the performance of the stock market has been historically weak during the summer months (May to October), has lost its significance in recent years. This is especially true as over the six-month span ending October, stocks have posted substantial returns over the past five years.

In fact, 2020 was a strong year with the S&P 500 logging more than 13% returns in the May-October period. The index also delivered robust returns of 9.1% in 2017, while the years 2016 and 2019 saw nearly 4% gains each. The year 2018 produced a return of 3.4%. Still, many investors have turned cautious this year given the high stock valuations.

Solid Market Trends

Both the American stock market and the economy are booming and have strongly recovered from the pandemic lows. This is especially true as the major bourses are hitting new highs while the economy expanded 6.4% year over year in the first quarter, representing the second-strongest increase since 2003 (read: 5 Top-Ranked ETFs to Ride on a Booming Economy).

Per the IMF projection, the United States will become the engine of global economy this year with the strongest growth in decades. The agency recently upgraded the U.S. economic growth forecast from 5.1% to 6.4% for this year. Rapid vaccinations, record fiscal stimulus and better-than-expected earnings have been acting as the major catalysts. In particular, the Conference Board on consumer confidence index in April jumped to the highest level since February 2020, underscoring that Americans are optimistic about economic conditions while retail sales surged the most since May 2020 in March.

Meanwhile, corporate results have turned out better than expected with all-around strength and momentum. Earnings from the 343 S&P members that reported Q1 results so far are up 49.2% on 10.6% higher revenues, with 87.5% beating EPS estimates and 78.1% beating revenue estimates. Both earnings and revenue growth are tracking above the group’s recent trend, including the pre-pandemic period.

In fact, the overall Q1 total earnings are on track to reach a new all-time quarterly record. Further, estimates for the current and coming quarters are steadily going up — a trend that has been in place since last summer. The positive revisions trend is likely to accelerate in the coming months as we start looking past the pandemic (read: ETFs to Play the Strong Q1 Earnings Trend).

However, inflationary fears and the potential tax hike could derail the stock rally and the economic recovery. This is because the surge in prices of commodities like lumber, copper and crude oil is likely to boost inflation while President Joe Biden's proposal to make a historic hike in capital gains tax will lead to sell-off in growth sectors in favor of value ones. Additionally, Treasury Secretary Janet Yellen’s latest comments made investors jittery. She said that the Federal Reserve might have to raise interest rates at some point to cool off an economy moving too fast though the Fed reiterated its dovish view by pledging to keep rates lower near zero through 2023.

Against such a backdrop, it might be foolish to quit the stock market altogether. Instead, investors could follow some strategies that could lead to a winning portfolio during this soft six-month period.

Make a Hot Sector Your Friend

Cyclical sectors such as industrials, energy, financials and materials have been soaring this year on improving economic health, as these are closely tied to economic growth. The speedy recovery path will lead to pent-up demand, resulting in higher demand for all types of products and services in the economy.

Some of the high-flying top-ranked ETFs from these sectors like Vanguard Industrial ETF (VIS - Free Report) , Invesco DWA Basic Materials Momentum ETF (PYZ - Free Report) , and SPDR S&P Regional Banking ETF (KRE - Free Report) could be excellent picks. These funds have Zacks ETF Rank #1 (Strong Buy) or 2 (Buy) (read: Banking Earnings Upbeat: Time to Buy Financial ETFs on Value?).

Bet on Quality

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. Further, academic research shows that high-quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term.

Among the most popular are iShares Edge MSCI USA Quality Factor ETF (QUAL - Free Report) , Invesco S&P 500 Quality ETF (SPHQ - Free Report) and Barron's 400 ETF (BFOR - Free Report) .

Emphasis on Thematic Investing

Thematic investing is enjoying a huge boom this year and becoming the most popular niche strategy as the pandemic has changed the consumer and business landscape, leading to new trends and new ways of investment. Notably, thematic ETFs do not invest in an entire market or single sector but rather in concepts, themes or trends. Investors are pouring a lot of money into these ETFs that are focused on themes like cloud computing, e-commerce, disruptive growth, work from home, video gaming, esports, marijuana, alternative energy or 3D printing (read: Thematic Investing on the Rise: ARK ETFs Leading the Pack).

The space has now become crowded with a variety of products. Among them, Amplify Seymour Cannabis ETF (CNBS - Free Report) and Amplify Transformational Data Sharing ETF (BLOK - Free Report) are the best-performing thematic ETFs of this year, gaining 50.1% and 44.4%, respectively.

Focus on Value

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.

Some of the Zacks ETF Rank #2 ETFs are Vanguard Value ETF (VTV - Free Report) , Schwab U.S. Large-Cap Value ETF (SCHV), and Vanguard Mega Cap Value ETF (MGV).

Overweight Dividend

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 worlds — safety in the form of payouts and stability in the form of mature companies that are less volatile to the large swings in stock prices. The companies that pay dividends generally act as a hedge against economic uncertainty and provide downside protection by offering outsized payouts or sizable yields on a regular basis.

In particular, ETFs with stocks having a strong history of dividend growth seem to be good picks. Vanguard Dividend Appreciation ETF (VIG - Free Report) and iShares Core Dividend Growth ETF (DGRO - Free Report) have a Zacks ETF Rank #2.

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