Volatility in the stock market has accelerated this week with the CBOE Volatility Index (VIX) hitting the highest level since the election amid escalating tension between the U.S. and North Korea. The fear gauge, which measures investors’ perception of market risk, spiked 44.4% in yesterday’s trading session. This suggests that investors have started to panic. Notably, the fear index was up 61.5% over the past three sessions.
Inside The Rising Tensions
Though tensions between the two countries were rife over the past several months amid new missile tests by the North Korea, the pace has escalated following tough sanctions imposed by United Nations Security Council last weekend that would slash North Korea’s $3 billion annual export revenue by a third. In the wake of this, North Korea continued its aggression and missile tests.
Trump’s warned on Tuesday that North Korea would face "fire and fury like the world has never seen" if it continues to threaten the U.S. Then North Korea retaliated with a threat that it is seeking a missile attack on the U.S. Pacific territory of Guam, which is home to a large U.S. military base, in mid-August (read: ETFs to Profit from US-North Korea Tensions).
Yesterday, Trump doubled down on his aggressive stance on North Korea by saying that his threat to unleash “fire and fury” on the country was not “tough enough”. The President told reporters that North Korea “better get their act together or they’re going to be in trouble like few nations ever have been in trouble in this world.”
The latest comment from Trump led to broad-based sell-off in the U.S. stocks for the third consecutive day for the first time since mid-April. All the three major benchmarks logged in their worst day since mid-May. The downward pressure might continue for at least the near term. As per CNBC report, stock strategists see a further 5% correction, just over 100 points, in the S&P 500 index.
Fundamentals Remain Strong
The current drop in the stock market seems to be short-lived given solid macro fundamentals. This is especially true, as the economy has been on a solid growth path buoyed by an impressive labor market, increase in wages, and increasing consumer spending. U.S. GDP growth expanded 2.6% annually in the second quarter, which is double the first-quarter growth of 1.2% and represents the fastest growth since the third quarter of last year when the economy grew 2.8%.
Additionally, consumers now appear to be more optimistic as we enter into the second half of the year. The Consumer Confidence Index, as indicated by the Conference Board, surged to a 16-year high of 121.1 in July from the revised 117.3 in June and is much above the expected 116.5. Further, corporate earnings has been strong with total Q2 earnings in dollar terms on track to reach a new quarterly all-time record for the index, surpassing the previous record achieved in the fourth quarter of 2016, as per the latest Earnings Trends (read: Q2 Earnings Effect: 4 Must-See ETF Charts).
Given the heightened geopolitical tension, investors seeking to remain invested in the equity world should follow some strategies that could safeguard them from downside while simultaneously offer capital appreciation opportunity. As such, we have highlighted certain ETF techniques that could lead to a winning portfolio in such a rough time.
Investors could try out safer avenues and rotate into defensive sectors, like utilities, healthcare, and consumer staples, which generally outperform during periods of low growth and high uncertainty. This is a much better option than holding cash. Guggenheim Defensive Equity ETF (DEF - Free Report) having a Zacks ETF Rank of 3 or Hold rating could be an excellent choice. This fund offers equal-weight exposure to all the stocks in the index, resulting in a more balanced and diversified portfolio. It helps the portfolio to better weather periods of volatility, while remaining positioned to take advantage of market upswings.
The other popular ETFs includConsumer Staples Select Sector SPDR Fund (XLP - Free Report) , Vanguard Consumer Staples ETF (VDC - Free Report) , SPDR Health Care Select Sector SPDR Fund (XLV - Free Report) , Vanguard Health Care ETF (VHT - Free Report) and iShares Dow Jones U.S. Healthcare Sector Index Fund (IYH - Free Report) ). XLP and VDC have a Zacks ETF Rank of 3 while the rest have a Zacks ETF Rank of 1 or Strong Buy rating.
Focus on Low Volatility & Low Beta
As North Korea tensions are expected to play foul in the stock market, low volatility and low beta ETFs appear sensible choices. These ETFs have the potential to outpace the broader market in bearish-to-neutral market conditions 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, and thus lose less when the market is crumbling.
While there are several options in the space, the most popular ones are PowerShares S&P 500 Low Volatility Portfolio SPLV, iShares Edge MSCI Min Vol USA ETF USMV and PowerShares Russell 1000 Low Beta Equal Weight Portfolio USLB. The trio has a Zacks ETF Rank of 3 (read: What Does High CAPE Ratio Mean for ETF Investing?).
Given the sliding markets, investors should tap this opportunity to buy stocks at a lower price in the form of ETFs. In particular, ETFs that offer broad exposure to various sectors, have Zacks ETF Rank of 3 and a lower P/E ratio as per etfdb.com seem good picks. Some of these include Guggenheim S&P SmallCap 600 Pure Value ETF (RZV - Free Report) , WisdomTree SmallCap Earnings Fund (EES - Free Report) , PowerShares S&P 500 Value Portfolio ETF SPVU and PowerShares Dynamic Large Cap Value Portfolio (PWV - Free Report) . These funds have a P/E ratio of 12.46, 12.85, 13.39, and 13.84, respectively.
Hedge Portfolio with Inverse ETFs
Investors worried about the growing U.S./North Korea tensions could also go short on stocks via ETFs. There are a number of inverse or leveraged inverse products currently available in the market that offer inverse (opposite) exposure to the various stock market indexes. While a leveraged play might be a risky option, inverse ETFs are interesting choices and provide hedging strategies in a bearish market (read: Time to Short U.S. Equities with ETFs?).
Below are the most popular options in this space for each market cap. Each of these is from a single issuer – Proshares.
Short S&P 500 ETF (SH - Free Report) andShort Dow30 (DOG - Free Report) provide inverse exposure to large cap stocks. Short S&P 500 ETFoffers the inverse performance of the S&P 500 while Short Dow30 targets the Dow Jones Industrial Average. Short QQQ ETF (PSQ - Free Report) seeks to deliver the opposite return of the Nasdaq 100 index.
Short MidCap400 MYY and Short Russell 2000 ETF RWM target the inverse performance of the mid and small cap segments of the broader U.S. market by tracking the S&P MidCap 400 and Russell 2000 indexes. Likewise, investors could also apply short strategies in different sectors through ETFs.
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