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Unlocking ETF Strategies for Sustained Investment Success
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Amid the continued rally on Wall Street due to the artificial intelligence (AI) frenzy, short sellers have ramped up bets against U.S. stocks. This is especially true as total U.S. short interest, or the amount that traders have spent betting against U.S. equities, exceeded $1 trillion this month, reaching the highest since April 2022. The activity signals a divergence in market sentiment, with a section of traders betting on a potential market downturn.
The increase in short bets came despite the fact that short sellers betting against the U.S. stock market have lost about $120 billion so far this year, per the WSJ. Notably, short selling is a strategy in which investors borrow a stock to sell with the expectation of buying it back at a lower price. Traders engage in short selling when they expect a company's stock price to decline, and want to make money if that happens.
Will the Rally Continue?
The U.S. stock market has been powered by the rise of AI technology, with the S&P 500 and the tech-heavy Nasdaq Composite index growing 15.3% and 29%, respectively, so far this year. Hopes that the Fed is nearing the end of its interest rate-hike cycle have helped the S&P 500 to recover from the lows seen in October last year. Easing inflation and stronger-than-expected corporate earnings added to the strength (read: 5 Stocks That Powered a Historic May for Nasdaq ETF).
However, a number of strategists and analysts predict that the rally might fizzle due to a combination of factors. Goldman mentioned that bullish options look crowded, indicating a potential overbought condition. It also noted that the rally has been narrow, which can be a sign of a less robust market as it means that fewer stocks are driving the uptrend.
As the big tech companies have largely driven the market rally this year, most of the stocks have become overvalued, creating an unsustainable bubble that could burst and result in sharp price declines. At its congressional testimony, Federal Reserve Chairman Jerome Powell reinforced the central bank's objective to rein in inflation and hinted at the likelihood of further interest rate hikes. He stated that the fight to lower inflation still has a "long way" to go. As the tech sector relies on borrowing for superior growth, it is expensive to borrow more money for further initiatives when interest rates are high.
Additionally, the stock market has priced in overly optimistic growth expectations, indicating that the market may be vulnerable to disappointments if those expectations are not met.
Goldman still sees a base case of the S&P 500 rising to 4,500 by year-end, suggesting they believe the market can continue to rise despite the potential risks. Still, they see a 23% downside to stocks in a recession scenario, highlighting the potential risks and volatility in the market (read: 5 Best Performing ETFs of the New Bull Market).
Given these factors, it may be prudent for investors to consider strategies for hedging their exposure to the S&P 500. This could involve a range of techniques, from using options contracts to protect against downside risk, to diversifying into other asset classes, or even taking a more defensive posture in their equity portfolios.
Low-Volatility Focus
Investing in low-volatility stocks can help reduce the overall risk in the portfolio. Low-volatility stocks tend to exhibit smaller price fluctuations and have more stable returns compared to the broader market. ETFs like iShares Edge MSCI Min Vol USA ETF (USMV - Free Report) and Invesco S&P 500 Low Volatility ETF (SPLV - Free Report) that focus on low-volatility stocks can provide an easy way to implement this strategy. These have a Zacks ETF Rank #3 (Hold).
Hedge Volatility
Volatility-hedged ETFs are investment products designed to mitigate the impact of market volatility on a portfolio. These ETFs typically aim to provide investors with exposure to a particular asset class or market while reducing the impact of price fluctuations resulting from market volatility. The basic premise behind volatility-hedged ETFs is to combine a long position in an underlying asset or market with a short position in volatility futures or options contracts. By shorting volatility, these ETFs attempt to offset or "hedge" the potential losses that may occur during periods of heightened market volatility.
Value investing is an investment strategy that focuses on purchasing stocks that are undervalued relative to their intrinsic value. Value stocks seek to capitalize on the inefficiencies in the market and have the potential to deliver higher returns with lower volatility compared with their growth and blend counterparts. These are less susceptible to the trending markets and their dividend payouts offer safety in times of market turbulence (read: Value ETF Investing to Shine as a Slowdown Looms Large).
Given this, Vanguard Value ETF (VTV - Free Report) , iShares Russell 1000 Value ETF (IWD - Free Report) , Vanguard Mega Cap Value ETF (MGV - Free Report) and Schwab U.S. Large-Cap Value ETF (SCHV - Free Report) , having a Zacks ETF Rank #1 (Strong Buy) could be excellent picks.
Quality Bet
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 quality ETFs are iShares Edge MSCI USA Quality Factor ETF (QUAL - Free Report) and Invesco S&P 500 Quality ETF (SPHQ - Free Report) .
Diversification
Investors should diversify their portfolios across various asset classes and sectors. This helps in spreading out risk and reduces the impact of underperformance in any single investment. Diversification can be done in various ways like investing in multi-assets, a variety of sectors, different countries or regions, a wide range of market caps, investment styles and many others.
In this regard, multi-asset ETFs like iShares Core Growth Allocation ETF (AOR - Free Report) and iShares Core Aggressive Allocation ETF (AOA - Free Report) , and long-short ETFs like Global X S&P 500 Covered Call ETF XYLD and First Trust Long/Short Equity ETF (FTLS - Free Report) could be good options. Multi-asset ETFs offer huge diversification benefits by investing across different asset classes, which have low correlations, thereby reducing overall volatility. These aim to provide a high level of current income with stability and potential for long-term appreciation while avoiding the downside risk of a specific asset class.
Meanwhile, a long/short strategy takes the best of both bull and bear predictions by involving buying and short selling of equities at the same time. This strategy is primarily used by hedge funds and involves taking long positions (buy) in stocks that are expected to increase in value while short positions (short sell) in stocks that are expected to decrease in value.
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Unlocking ETF Strategies for Sustained Investment Success
Amid the continued rally on Wall Street due to the artificial intelligence (AI) frenzy, short sellers have ramped up bets against U.S. stocks. This is especially true as total U.S. short interest, or the amount that traders have spent betting against U.S. equities, exceeded $1 trillion this month, reaching the highest since April 2022. The activity signals a divergence in market sentiment, with a section of traders betting on a potential market downturn.
The increase in short bets came despite the fact that short sellers betting against the U.S. stock market have lost about $120 billion so far this year, per the WSJ. Notably, short selling is a strategy in which investors borrow a stock to sell with the expectation of buying it back at a lower price. Traders engage in short selling when they expect a company's stock price to decline, and want to make money if that happens.
Will the Rally Continue?
The U.S. stock market has been powered by the rise of AI technology, with the S&P 500 and the tech-heavy Nasdaq Composite index growing 15.3% and 29%, respectively, so far this year. Hopes that the Fed is nearing the end of its interest rate-hike cycle have helped the S&P 500 to recover from the lows seen in October last year. Easing inflation and stronger-than-expected corporate earnings added to the strength (read: 5 Stocks That Powered a Historic May for Nasdaq ETF).
However, a number of strategists and analysts predict that the rally might fizzle due to a combination of factors. Goldman mentioned that bullish options look crowded, indicating a potential overbought condition. It also noted that the rally has been narrow, which can be a sign of a less robust market as it means that fewer stocks are driving the uptrend.
As the big tech companies have largely driven the market rally this year, most of the stocks have become overvalued, creating an unsustainable bubble that could burst and result in sharp price declines. At its congressional testimony, Federal Reserve Chairman Jerome Powell reinforced the central bank's objective to rein in inflation and hinted at the likelihood of further interest rate hikes. He stated that the fight to lower inflation still has a "long way" to go. As the tech sector relies on borrowing for superior growth, it is expensive to borrow more money for further initiatives when interest rates are high.
Additionally, the stock market has priced in overly optimistic growth expectations, indicating that the market may be vulnerable to disappointments if those expectations are not met.
Goldman still sees a base case of the S&P 500 rising to 4,500 by year-end, suggesting they believe the market can continue to rise despite the potential risks. Still, they see a 23% downside to stocks in a recession scenario, highlighting the potential risks and volatility in the market (read: 5 Best Performing ETFs of the New Bull Market).
Given these factors, it may be prudent for investors to consider strategies for hedging their exposure to the S&P 500. This could involve a range of techniques, from using options contracts to protect against downside risk, to diversifying into other asset classes, or even taking a more defensive posture in their equity portfolios.
Low-Volatility Focus
Investing in low-volatility stocks can help reduce the overall risk in the portfolio. Low-volatility stocks tend to exhibit smaller price fluctuations and have more stable returns compared to the broader market. ETFs like iShares Edge MSCI Min Vol USA ETF (USMV - Free Report) and Invesco S&P 500 Low Volatility ETF (SPLV - Free Report) that focus on low-volatility stocks can provide an easy way to implement this strategy. These have a Zacks ETF Rank #3 (Hold).
Hedge Volatility
Volatility-hedged ETFs are investment products designed to mitigate the impact of market volatility on a portfolio. These ETFs typically aim to provide investors with exposure to a particular asset class or market while reducing the impact of price fluctuations resulting from market volatility. The basic premise behind volatility-hedged ETFs is to combine a long position in an underlying asset or market with a short position in volatility futures or options contracts. By shorting volatility, these ETFs attempt to offset or "hedge" the potential losses that may occur during periods of heightened market volatility.
iMGP DBi Managed Futures Strategy ETF DBMF, Aptus Drawdown Managed Equity ETF ADME, Invesco S&P 500 Downside Hedged ETF (PHDG - Free Report) and First Trust Managed Futures Strategy Fund FMF looks exciting.
Value Addition
Value investing is an investment strategy that focuses on purchasing stocks that are undervalued relative to their intrinsic value. Value stocks seek to capitalize on the inefficiencies in the market and have the potential to deliver higher returns with lower volatility compared with their growth and blend counterparts. These are less susceptible to the trending markets and their dividend payouts offer safety in times of market turbulence (read: Value ETF Investing to Shine as a Slowdown Looms Large).
Given this, Vanguard Value ETF (VTV - Free Report) , iShares Russell 1000 Value ETF (IWD - Free Report) , Vanguard Mega Cap Value ETF (MGV - Free Report) and Schwab U.S. Large-Cap Value ETF (SCHV - Free Report) , having a Zacks ETF Rank #1 (Strong Buy) could be excellent picks.
Quality Bet
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 quality ETFs are iShares Edge MSCI USA Quality Factor ETF (QUAL - Free Report) and Invesco S&P 500 Quality ETF (SPHQ - Free Report) .
Diversification
Investors should diversify their portfolios across various asset classes and sectors. This helps in spreading out risk and reduces the impact of underperformance in any single investment. Diversification can be done in various ways like investing in multi-assets, a variety of sectors, different countries or regions, a wide range of market caps, investment styles and many others.
In this regard, multi-asset ETFs like iShares Core Growth Allocation ETF (AOR - Free Report) and iShares Core Aggressive Allocation ETF (AOA - Free Report) , and long-short ETFs like Global X S&P 500 Covered Call ETF XYLD and First Trust Long/Short Equity ETF (FTLS - Free Report) could be good options. Multi-asset ETFs offer huge diversification benefits by investing across different asset classes, which have low correlations, thereby reducing overall volatility. These aim to provide a high level of current income with stability and potential for long-term appreciation while avoiding the downside risk of a specific asset class.
Meanwhile, a long/short strategy takes the best of both bull and bear predictions by involving buying and short selling of equities at the same time. This strategy is primarily used by hedge funds and involves taking long positions (buy) in stocks that are expected to increase in value while short positions (short sell) in stocks that are expected to decrease in value.