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4 ETF Areas Appear Most Vulnerable to Market Turbulence

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Despite the acute coronavirus scare and global lockdowns, Wall Street ripped higher on the unprecedented U.S. central bank and government stimulus in recent times. After hitting the bottom on Mar 23, the S&P 500 skyrocketed more than 42% till Jun 10. However, the stupendous rally halted on Jun 11. Overall, Wall Street was in the red for the week ended Jun 12.

A host of factors contributed to the crash. Another 1.542 million Americans claimed unemployment benefits amid COVID-19 crisis. The other dampeners were signs of rising coronavirus cases with easing lockdowns in Arizona and Texas, the Fed’s cautious outlook on the economy, and chances of a rise in corporate taxes if Democrats make it to the presidency this year.

Many have hoped for a V-shaped recovery, especially after the surprisingly upbeat May jobs report and some better-than-expected economic data points. However, in the latest policy meeting, Federal Reserve Chair Jerome Powell poured some cold water on the extra-euphoric Wall Street bulls.

The Fed now expects the U.S. unemployment rate to hit 9.3% this year, dropping to 6.5% in 2021 and declining further to 5.5% in 2022. The Fed sees American GDP falling 6.5% in 2020 before rising 5.0% in 2021 and 3.5% in 2022. The U.S. economy is in recession now, but Wall Street had soared ahead of fundamentals in the last two months.

Will Markets Skid Ahead?

CFRA’s Sam Stovall said the market has been highly overbought and the sell-off on Jun 11 could mark the beginning of a bigger pullback. Stovall said stocks could decline 5% to 10% from the Jun 8 peak. Notably, Barry Bannister, head of institutional equity strategy at Stifel, lowered his price target for the S&P 500 to 3100 in December, from 3250 in August, putting stress on the likely shift in power in this year’s election.

Against this backdrop, below we highlight a few ETF areas that are most vulnerable now and could be hit hard if markets remain volatile in the coming days. One can think about the inverse plays of the below-mentioned areas if there is a market crash.

Small-Caps – Direxion Daily Small Cap Bear 3X Shares (TZA - Free Report)

Investors should note that coronavirus-led slowdown have left small-cap companies with a severe cash crunch. Though the Fed’s Main Street Lending Program and U.S. government’s aid have propelled the space in recent weeks, any downturn would be hazardous for the segment. The small-cap Russell 2000, entered correction territory in just three days last week — marking the fastest decline since December 2008.

Financials – Direxion Daily Financial Bear 3X Shares (FAZ - Free Report)

The beleaguered financial sector, one of the hardest-hit amid the pandemic, picked up in recent times on signs of faster economic recovery. However, the Fed’s zero rate policy and a QE do not bode well for banks’ net interest rate margin.

Moreover, the Fed may renew its World War II-era policy of capping yields on U.S. government debt. Fed chair Powell added that the effectiveness of yield curve control “remains an open question.” Notably, yield curve control involves direct bond purchases of longer-dated U.S. government debt until those bond yields are held below targeted levels. If this happens, banking stocks will take a hit.

Fossil Fuel/Oil – Direxion Daily Energy Bear 2X Shares (ERY - Free Report)

If there is a double-dip recession, demand for oil will remain subdued. Moreover, travel demand will remain lackluster globally as long as the coronavirus threat if rife. If this isn’t enough, Republican President Trump has been a proponent of fossil fuel. If Democrats gets the power of the Senate this year, the trend reversal may be in favor of clean energy stocks.

Materials – ProShares Ultra Short Basic Materials (SMN - Free Report)

Materials stocks are largely tied to economic growth. So, if growth and the resultant demand slacken, we may see a dip in these. Moreover, the industrial and materials sectors were great beneficiaries in the Trump era. So, coronavirus and the possibility of a return of the Democratic era may trouble this space.

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