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Fed Plans QE Taper: Time for Cyclical Sector ETFs?

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Wall Street has rallied hard this year on vaccine distribution, a prolonged period of easy money policy and fiscal stimulus. Stronger-than-expected earnings are the major catalysts at present. The Q2 earnings picture has been robust, with aggregate total quarterly earnings on track to reach a new all-time record. The strength has been palpable on the revenue side.

Inflation is running high, which may compel the Fed to taper QE. Jobs market has also improved a lot. The U.S. unemployment rate dropped to 5.2% in August, well below the April 2020 peak of 14.8%, but still higher than the 3.5% rate recorded in February 2020, just before the pandemic started. This points to the decent economic growth momentum (read: Fed Taper to Start in November? 7 ETFs to Buy).

The U.S. economy grew 6.5% in the second quarter buoyed by a robust economic recovery. In absolute term, U.S. GDP in second-quarter 2021 came in at $19.4 trillion, exceeding $19.2 trillion recorded in fourth-quarter 2019, the last quarter before the global outbreak of coronavirus.

If this was not enough, fiscal stimulus is in the fine fettle. On Aug 10, the U.S. Senate had passed a bipartisan infrastructure bill of $550 billion in addition to the previously approved funds of $450 billion for five years. Moreover, pent-up demand from the lockdown will also materialize once vaccination will be complete and booster shots will take momentum.

While such optimism has triggered rising rate risks and the associated risks for rising inflation, Chief Investment Officer of HSBC Wealth Management Xian Chan said that after a period of concern about consistently higher inflation, markets appear to have got immune to such threats, as quoted on CNBC. It means stocks will rally as investors are ignoring inflation.

We expect some cyclical sectors will likely fare better. Notably, cyclical industries are sensitive to the business cycle. These industries generate higher volume of revenues in periods of broader economic expansion and vice versa. 

Against this backdrop, below we highlight a few sector ETFs that could gain ahead.

SPDR S&P Bank ETF (KBE - Free Report)

Banking stocks were extremely beaten down in the peak of the pandemic as fears of higher defaults at the household and corporate levels hit the space hard. Banking stocks offer value now. Banking stocks are highly cyclical as these are vulnerable to changes in economic conditions and policies. Moreover, taper talks are doing rounds. This would steepen the yield curve and favor bank stocks and ETFs.

Consumer Discretionary Select Sector SPDR ETF (XLY - Free Report)

If job data remains stable and rates remain at the moderate levels, consumers may splurge on discretionary activities. This is especially true given the all-important holiday season is approaching.  However, volatility should remain in place on COVID fear. The underlying Consumer Discretionary Select Sector Index of the fund seeks to provide an effective representation of the consumer discretionary sector of the S&P 500 Index.

Industrial Select Sector SPDR ETF (XLI - Free Report)

The sector has suffered massively amid the pandemic. With millions of Americans still unemployed, the creation of blue-collar jobs would be of high priority. The latest recruitment pattern in the sector also calls for optimism. The infrastructure bill is an added advantage.

Vanguard Real Estate Index Fund ETF Shares (VNQ - Free Report)

The real estate corner of the broad market has been an area to watch lately given the market volatility that has returned the lure for rate-sensitive sectors. This is because these often act as a safe haven in times of market turbulence and concurrently offer higher returns due to their outsized yields. If rates rise amid the Fed taper, higher yields of the real estate sector may favor the fund. Additionally, rising rents due to shortage of homes and rising inflation are driving the sector higher.