ETF Focus Rewind: Buying Low On Low Volatility
Low volatility stocks are trying to make a comeback, while online retail looks positioned for a rebound.
2 ETFs To Consider Buying (And 1 To Avoid) This Week
The big question surrounding the financial markets right now, in my opinion, is where does the economic recovery stand and how long might it be delayed if the delta variant of the coronavirus becomes a more widespread problem. The markets reacted last week as if this situation is growing a bit more pessimistic and investors reacted accordingly. Utilities & consumer staples outperformed. Treasuries rallied at the end of last week. Small-caps underperformed significantly. Even though the S&P 500 keeps pushing higher, other asset classes are indicating a wave of defensiveness.
Perhaps the most telling number from last week was the University of Michigan consumer sentiment index reading from August. It fell all the way from 81.2 last month to 70.2 this month, its lowest reading since all the way back in 2011. According to this, consumer sentiment is worse today than it was during the worst of the COVID pandemic.
The equity markets have been emotionally driven for the past year by pushing higher and higher despite mixed economic data. As long as the Fed keeps having their back, there's justification for continuing to buy stocks (at least that's the belief from many). That's why I think this reading is so important. If consumers believe they're less confident in the recovery, their financial positions and their ability to spend, that could mean the markets are now susceptible to an emotional sell-off that could pull equity prices back into correction territory.
I think this is the main reason why we saw Treasuries rise sharply on Friday of last week - a flight to safety. Utilities stocks rose sharply. Even gold, which had mostly been stuck in neutral, clawed back to post gains. All of these assets suggest there's a defensive pivot taking place right now.
And let's not forget that the Congressional battle over the infrastructure bill, the $3.5 trillion economic package and the debt ceiling debate could all be coming to a head over the next month, which might ignite volatility even further.
With that being said, here are three ETFs I'm going to be watching this week and the narratives that go along with them.
Amplify Online Retail ETF (IBUY)
Online retail was the hot sector coming out of the COVID bear market bottom. As business shut down and people stayed home, all of that brick and mortar commerce shifted to the online channel and stocks heavily exposed to the online space thrived. This year, however, has been a different story. As the economy has reopened, online retail stocks have been stagnant. IBUY is actually trailing the S&P Retail Index by 8% year-to-date.
The next move for this sector, I believe, is where the economy heads in relation to COVID. We know that the delta variant is spreading quickly, but there's no inclination by almost anyone to begin closing businesses again. That should continue to be supportive of retail sales figures, but the question is if the online channel can reassert control.
I'd prefer to own the online retail sector here over the broader retail space. The delta variant is renewing some fears of being out in public places again and that could bode well for the return on online stocks. By almost all valuation metrics - P/E, P/S, P/B - this group is still expensive, but I like the opportunity set here for this group to rebound.
First Trust Dorsey Wright Momentum & Low Volatility ETF (DVOL)
I find DVOL very interesting to watch right now because 1) it's a play on two different themes - momentum and low volatility - that haven't performed particularly well in 2021, but 2) it's a fund that's performed very well in its own right. The iShares MSCI USA Momentum Factor ETF (MTUM) is up 12% year-to-date, while the iShares MSCI USA Minimum Volatility Factor ETF (USMV) has gained 14%. DVOL, however, is up nearly 19%, which speaks well of Dorsey Wright's relative strength management strategy.
Like many momentum strategies, its recent rebalance featured a heavy pivot from growth stocks into cyclical sectors. This move resulted in a move to value stocks at the worst time when they fall back out of favor. DVOL hasn't really had that issue despite a portfolio that now has a 50% allocation to the combination of industrials and financials.
That means your opinion of DVOL really should depend on how you think cyclicals are going to perform. In recent weeks, investors have moved away from growth back into cyclicals led by a rebound in financials and bank stocks. With the market turning defensive, as I discussed above, an overweight to value and low volatility stocks might not be a bad idea. After underperforming steadily for a year straight following the 2020 bear market bottom, low volatility has managed to keep pace with the S&P 500 since March of this year. I think now could be a good time to consider adding to positions in these groups again.
Invesco Dynamic Leisure & Entertainment ETF (PEJ)
The idea of avoiding the leisure and entertainment is a pure play on the idea that the delta variant could impact the hotel, cruise line and airline sectors again. Plain and simple. This group was one of the worst hit when COVID first became a thing since it pretty much shut down the entire leisure sector indefinitely. When things began looking more optimistic and it appeared the rebound would be relatively quick as the economy reopened, leisure stocks rocketed higher.
The group hasn't been shut down again as it was before, but there are signs that demand is waning again. Oil prices are heading down in anticipation of lower global energy demand. Airlines are beginning to cut flights, especially in China where the reimposition of restrictions has been more severe. Plus, we're coming to the end of the summer travel season.
I think the current trend in this sector is heading downward. Given current conditions, both economically and health-wise, I'd expect some downward revisions in expectations. When that occurs, I suspect stock prices could react swiftly.
Chart of the Week
The ETF marketplace has taken in nearly $550 billion in new money so far in 2021. The inflows have been widespread, although equity ETFs have taken in the lion’s share of new dollars. One group that hasn’t participated, however, is low volatility stocks.
The more than 80 different equity ETFs out there that target low volatility stocks as part of their strategy have collectively LOST $15 billion this year. The iShares MSCI USA Minimum Volatility Factor ETF (USMV) alone accounts for more than half of that.
The reason for this has been pretty clear as you can see in the chart above. Low volatility stocks have underperformed the S&P 500 consistently from the COVID bear market bottom through the end of February of this year. Growth stocks initially led the rebound when it became clear that the recession wouldn’t be prolonged, while cyclicals took leadership during periods when economic growth figures looked strong. Defensive issues fell out of favor and investors abandoned their positions.
That’s changed over the past six months. Low volatility stocks aren’t yet outperforming the broader market, but they’ve established a nice 6-month long base here, which indicates that the bleeding has finally stopped. The outflows from this group are still occurring, but that’s been mostly due to reputation at this point as opposed to current performance.
With economic growth slowing, uncertainty over how the debt ceiling battle will pan out and the Fed looking to slowly tighten policy later this year by curbing asset purchases all looming, I believe that the time for low volatility stocks could be returning. We’ve already seen utilities stocks outperforming lately and Treasury yields continue to push lower instead of higher. That’s an indication that defensive assets are all gaining favor from investors and low volatility could soon come along for the ride.
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