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5 ETF Strategies to Follow in May

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After registering the worst month of the year, Wall Street might find difficulty in regaining momentum in May due to weak seasonal trends. This is especially true given 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). However, stocks have posted substantial returns over the past decade during the six months ending October.

Though May through October has been historically weak for stocks, LPL's Ryan Detrick found that the S&P 500 was up 9 out of the last 10 years from May through October, delivering an average return of 5.7%.

What’s In Store for This Year?

The S&P 500 saw the worst start to a year since 1939, plunging more than 13% on myriad worries. Firstly, the Federal Reserve is about to start raising interest rates more aggressively to fight inflation that will hit consumers and businesses. Secondly, COVID-19 variant concerns and the resultant lockdown measures in China have sparked worries over global economic expansion that will continue to weigh on investors’ sentiment.

Notably, the U.S. economy shrank for the first time since the outbreak of the pandemic. GDP dropped 1.4% annually in the first quarter of 2022, marking a sharp reversal from 6.9% annual growth in the fourth quarter (read: U.S. Economy Shrinks in Q1: ETFs to Win/Lose).

Further, a war in Ukraine worsened disruptions in the flow of goods across borders, resulting in skyrocketing food and energy prices, and threatening corporate profits. Corporate results have turned out weaker than expected for the first quarter. Total earnings for the 177 S&P 500 companies that have reported Q1 results so far are up 1.1% on 11.4% higher revenues, with 80.8% beating EPS estimates and 72.9% beating revenue estimates, per the Earnings Trends report. The Q1 EPS and revenue beat percentages are at the lowest level since the second quarter of 2020 for the same group of companies.

As a whole, Q1 S&P 500 earnings are expected to be up 6.6% from the same period last year on 11.1% higher revenues. This is a significant deceleration from each of the last three preceding quarters.

Against such a backdrop, investors could follow some strategies that could lead to a winning portfolio during this soft six-month period.

Bet on Rate-Friendly Sectors

A rising rate environment is highly beneficial for cyclical sectors like financials, industrials and consumer discretionary. Investors seeking protection against rising rates could load up stocks in these sectors through diversified ETFs or products targeting these sectors. Some of the broad ETFs having double-digit exposure to these four sectors are Vanguard Total Stock Market ETF (VTI - Free Report) and Schwab U.S. Broad Market ETF SCHB. Other sectors make up for a smaller part of the portfolio of these funds. All these funds have a Zacks ETF Rank #2 (Buy).

Investors seeking a concentrated exposure to the particular sector could find top-ranked Financial Select Sector SPDR Fund (XLF - Free Report) , Vanguard Industrials ETF (VIS - Free Report) and Invesco S&P SmallCap Consumer Discretionary ETF (PSCD - Free Report) intriguing. All these funds have a Zacks ETF Rank #1 (Strong Buy) or 2, suggesting their outperformance in the coming months.

Add Value to Your Portfolio

Amid a myriad of woes, value investing seems appealing to investors. This is because value stocks, which have strong fundamentals — earnings, dividends, book value and cash flow — and trade below their intrinsic value, will likely benefit from growth in the economy and simultaneously from bouts of stock market volatility (read: Why Value ETFs May Outdo Growth for the Rest of 2022).

Value stocks seek to capitalize on the inefficiencies in the market and have the potential to deliver higher returns with lower volatility compared with the growth and blend counterparts. These are less susceptible to the trending markets and their dividend payouts offer safety in times of market turbulence. Given this, Vanguard Value ETF (VTV - Free Report) , iShares Russell 1000 Value ETF (IWD), Vanguard Mega Cap Value ETF MGV and Schwab U.S. Large-Cap Value ETF (SCHV - Free Report) , having a Zacks ETF Rank #1 could be excellent picks.

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) .

Focus on Low Volatility

Low-volatility ETFs have the potential to outpace the broader market in an uncertain environment providing significant protection to the portfolio. This is because these funds include more stable stocks that have experienced the least price movement in their portfolio. Further, these allocate more to defensive sectors with a higher distribution yield than the broader markets. ETFs like iShares Edge MSCI Min Vol USA ETF (USMV - Free Report) and Invesco S&P 500 Low Volatility ETF (SPLV - Free Report) could be compelling choices. These have a Zacks ETF Rank #2 or 3 (Hold).

Emphasis on Dividends

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 (read: A Guide to the 10 Most-Popular Dividend ETFs).

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 have a Zacks ETF Rank #1.