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After a smooth ride in the third quarter, volatility is the key concern for the U.S. stocks in the final quarter given corporate earnings, the presidential election, the final OPEC deal, ECB tapering talks and the possible rate hike by the Fed in December. All these will continue to weigh on investor sentiment.

In particular, higher rates would result in tighter lending conditions and curtail consumer spending on a wide range of products including cars and houses. This in turn will hurt profitability across various segments. Further, the U.S. dollar hit its highest level in two months against the basket of currencies. This will have a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments like utilities and real estate (read: ETF Strategies for a Rising Rate Environment).

However, the spate of strong data, increase in oil price as well as expectations for better Q3 earnings bolstered confidence in the economy and could thereby set the stage for the stock rally. After four straight quarters of negative profit growth, the third-quarter earnings season for the S&P 500 index is expected to be the turning point wherein growth could come by, as per earnings tracker Thomson Reuters I/B/E/S.

Heightened volatility and uncertainty in the markets have made investors cautious about their stock investments . It would thus be better to focus on fundamentals and invest in “quality” ones.

Why Quality Investing?

Quality stocks are rich in value characteristics with healthy balance sheets, high return on capital, low volatility, elevated margins, and a track record of stable or rising sales and earnings growth. These stocks 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.

Given this, we have highlighted five solid picks each from the ETF and stock worlds, targeting this niche strategy. Any of these could enjoy smooth trading and outperform the U.S. market in the coming months.

ETF Picks

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

This fund provides exposure to the stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth, and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index (read: 4 Best ETFs & Stocks to Tap the Tech Boom).

No. of Holdings: 124
Expense Ratio: 0.15%
AUM: $3.2 billion
Average Daily Volume: 352,000 shares
Concentration Risk (as per Fidelity): 12.56%
Top Sector: Information Technology
YTD Returns: 5.58%

PowerShares S&P 500 Quality Portfolio (SPHQ - Free Report)

This fund tracks the S&P 500 High Quality Rankings Index, a benchmark of S&P 500 stocks that demonstrate the greatest quality characteristics.

No. of Holdings: 99
Expense Ratio: 0.29%
AUM: $1.1 billion
Average Daily Volume: 284,000 shares
Concentration Risk: 12.73%
Top Sector: Consumer Discretionary
YTD Returns: 9.27%

Barron's 400 ETF (BFOR - Free Report)

This ETF seeks to track the performance of the rules-based and fundamentals-driven Barron’s 400 Index. The benchmark uses the MarketGrader's fundamental analysis to select America’s highest-performing stocks based on growth, valuation, profitability and cash flow.

No. of Holdings: 403
Expense Ratio: 0.65%
AUM: $169.7 million
Average Daily Volume: 13,000 shares
Concentration Risk: 1.34%
Top Sector: Consumer Discretionary
YTD Returns: 6.85%

SPDR MSCI USA StrategicFactors ETF (QUS - Free Report)

This fund offers exposure to stocks that have a combination of value, low volatility and quality factor strategies. This is done by tracking the MSCI USA Factor Mix A-Series Index.

No. of Holdings: 613
Expense Ratio: 0.15%
AUM: $12.5 million
Average Daily Volume: 2,000 shares
Concentration Risk: 7.59%
Top Sector: Information Technology
YTD Returns: 5.48%

FlexShares Quality Dividend Index Fund (QDF - Free Report)

This ETF follows the Northern Trust Quality Dividend Index and uses a proprietary model that includes factors like profitability, management efficiency and cash flow (read: Beat the Market with These High Dividend ETFs & Stocks).

No. of Holdings: 162
Expense Ratio: 0.37%
AUM: $1.4 billion
Average Daily Volume: 98,000 shares
Concentration Risk: 9.25%
Top Sector: Information Technology
YTD Returns: 10.54%

Stock Picks

To find out the best stocks in this space, we have used the Zacks stock screener. The parameters include Zacks Rank #1 (Strong Buy) or 2 (Buy), VGM Style Score of ‘A’ or ‘B’, ROE of at least 10%, debt-to-equity ratio of less than 1, historically positive 5-year EPS growth, positive current-year EPS growth, positive current-year earnings estimate revisions over the past 30 days, and dividend yield of greater than 1%.

Dick's Sporting Goods Inc. (DKS - Free Report)

Based in Coraopolis, Pennsylvania, Dick's Sporting Goods is a leading full-line sporting goods retailer in the United States.

Zacks Stock Rank: #2
VGM Style Score: A
ROE: 18.43%
Debt/Equity: 0.09
5 Year Historical EPS Growth: 8.35%
Fiscal Year Earnings Growth: 5.9%
Positive Earnings Estimate Revisions Over 30 Days: 0.33%
Dividend Yield: 1.04%

ABM Industries Incorporated (ABM - Free Report)

Based in New York, ABM Industries is a provider of integrated facility solutions in the United States and internationally.

Zacks Stock Rank: #2
VGM Style Score: B
ROE: 10.15%
Debt/Equity: 0.22
5 Year Historical EPS Growth: 6.75%
Fiscal Year Earnings Growth: 7.61%
Positive Earnings Estimate Revisions Over 30 Days: 8.79%
Dividend Yield: 1.68%

Thor Industries Inc. (THO - Free Report)

Based in Elkhart, Indiana, Thor Industries designs, manufactures, and sells recreational vehicles, and related parts and accessories primarily in the United States and Canada (read: Top-Ranked Sector ETFs & Stocks for Q4).

Zacks Stock Rank: #2
VGM Style Score: A
ROE: 22.5%
Debt/Equity: 0.28
5 Year Historical EPS Growth: 21.27%
Fiscal Year Earnings Growth: 15.74%
Positive Earnings Estimate Revisions Over 30 Days: 5.06%
Dividend Yield: 1.40%

Steelcase Inc. (SCS - Free Report)

Based in Grand Rapids, Michigan, Steelcase is a designer, manufacturer, and distributor of an integrated portfolio of furniture settings, user-centered technologies, and interior architectural products.

Zacks Stock Rank: #2
VGM Style Score: A
ROE: 17.38%
Debt/Equity: 0.40
5 Year Historical EPS Growth: 13.30%
Fiscal Year Earnings Growth: 6.73%
Positive Earnings Estimate Revisions Over 30 Days: 0.91%
Dividend Yield: 3.47%

Worthington Industries Inc. (WOR - Free Report)

Based in Columbus, Ohio, Worthington Industries is one of the leading diversified metal processing companies (read: Top Sectors of Q3 and Their Best ETFs).

Zacks Stock Rank: #1
VGM Style Score: A
ROE: 21.60%
Debt/Equity: 0.59
5 Year Historical EPS Growth: 6.51%
Fiscal Year Earnings Growth: 27.02%
Positive Earnings Estimate Revisions Over 30 Days: 18.87%
Dividend Yield: 1.68%

In Conclusion

Quality ETFs and stocks often provide hedge against market volatility. Adding any of the above-mentioned products to one’s long-term portfolio could be worthwhile thanks to their credit worthiness and soundness.

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