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Winning ETF Strategies for the Fourth Quarter

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Volatility has roared back with the start of the fourth quarter as the CBOE Volatility Index (VIX), also known as the fear gauge, jumped to more than 28, its highest level since Feb 12, 2018. This suggests that market fears have started to set in. This fear gauge tends to outperform when markets are falling or fear levels over the future are high.

The global equity index dropped to a one-year low while the three major U.S. market indexes slipped to below the 200-day moving average. Notably, Dow Jones Industrial Average shed nearly 1400 points in the past couple of days, while the tech-heavy Nasdaq Composite Index entered into correction territory, declining about 10% from its peak reached on Aug 29 (read: Profit From Market Bloodbath With These Inverse ETFs).

This is primarily thanks to a spike in Treasury yields that has triggered speculation for faster-than-expected rates hikes and diminished the appeal for riskier assets. The political turbulence in Italy added to the uncertainty as the war of words between Rome and the European Union over the country’s budget escalated. Additionally, intensified U.S.-China trade war, ongoing troubles in emerging markets, Iran oil sanctions, another budget deadline and the mid-term election in November will continue to weigh on stocks.

Further, the International Monetary Fund (IMF) reduced its global growth forecast by 0.2 percentage points for this year and the next, citing that trade tensions between the United States and its trading partners have started to hurt economic activity worldwide (read: IMF Cuts Global Growth Forecast: ETFs in Focus).

Nonetheless, the accelerating U.S. economic growth, historic tax cuts, record employment, surging corporate profits, and 18-year high consumer confidence are boosting confidence in the stock market that will keep the positive momentum alive.

Against such a sluggish backdrop, it is difficult to plan investments that could fetch sure-shot returns. In this case, they should focus on certain techniques or strategies while building a portfolio that is sure to pay off in the coming months. We share some of these with you:

Bet on Earnings

The Q3 earnings season is expected to be a solid one, with total earnings for the S&P 500 likely to be up 17.8% from the same period last year on 7.1% higher revenues. This is the sixth quarter in the last seven of double-digit earnings growth. Energy remained at the top spot and has the strongest growth projection of 92% for Q3. This is followed by earnings growth of 39.5% for construction, 34.9% for basic materials, 29.3% for financials, and 20.9% for transportation.

Some of the ETFs that could make a great play based on this assumption include SPDR S&P Oil & Gas Exploration & Production ETF XOP, Vanguard Energy ETF VDE, iShares U.S. Home Construction ETF ITB, First Trust Materials AlphaDEX Fund FXZ and Financial Select Sector SPDR Fund XLF. XOP, VDE, ITB have a Zacks ETF Rank #3 (Hold) while FXZ and XLF have a Zacks ETF Rank #2 (Buy). 

Prepare for Volatility

Investors should prepare themselves for twists and turns arising from the bitter U.S.-China tariff talks and its impact on global economic growth. While there are many ways to survive the market turmoil, investing in lower volatility ETFs or low beta ETFs could reduce losses in declining markets, while generate decent returns when the markets rise.

ETFs like iShares MSCI USA Minimum Volatility Index Fund USMV, PowerShares S&P 500 Low Volatility Fund SPLV, First Trust Low Beta Income ETF FTLB and PowerShares Russell 1000 Low Beta Equal Weight Portfolio USLB could be compelling choices. Most of these have a Zacks ETF Rank #3 (read: 4 Low Volatility ETF Plays for a Rocky Market).

Focus on Quality

Quality stocks are rich in value characteristics with healthy balance sheets, high return on capital, low volatility, elevated margins, and a track 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.

Some of the funds in this category, MSCI USA Quality Factor ETF QUAL, PowerShares S&P 500 High Quality ETF SPHQ and Barrons 400 ETF BFOR are worth a look.

Add Value to Your Portfolio

Value ETFs have proven to be outperformers over the long term and are less susceptible to trending markets. This is because value stocks have strong fundamentals — earnings, dividends, book value and cash flow — that trade below their intrinsic value and are undervalued (read: Value ETFs Regain Momentum: Will This Last?).

As such, value ETFs have the potential to deliver higher returns and exhibit lower volatility compared with their growth and blend counterparts. Among these, Schwab U.S. Large-Cap Value ETF SCHV, Vanguard Mega Cap Value ETF MGV and SPDR S&P 500 Value ETF SPYV have a Zacks ETF Rank #2.

Hedge Against Volatility

Against the backdrop of heightened volatility and accelerating domestic economy, investors may want to build position in the U.S. markets to take advantage of the beaten down prices. In order to exploit this trend, volatility-hedged ETFs could prove beneficial. These funds have the potential to stand out and outperform the simple vanilla funds in case of rising volatility. The most popular of these are DeltaShares S&P 500 Managed Risk ETF DMRL, Nationwide Risk-Based U.S. Equity ETF (RBUS - Free Report) and PowerShares S&P 500 Downside Hedged Portfolio PHDG.

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