ETF Focus Rewind: The Storm Is Near

Make no mistake about it. The financial markets are flashing warning signs right now.

Jul 19, 2021

2 ETFs To Consider Buying (And 1 To Avoid) This Week

Make no mistake about it. The financial markets are flashing warning signs right now. Even though the S&P 500 is within 1% of its all-time high and the VIX is still below 20, there are plenty of signals indicating that not only are things not well under the surface, but they could be setting up to reverse.

Treasuries continue to rally even in the face of rising short-term inflation. Lumber prices are crashing beyond the point where they started their parabolic rise last October. Small-caps have underperformed the S&P 500 by 15% since the beginning of March. And last week, utilities stocks beat the S&P 500 by nearly 4%. You could make the argument that it's worth at least keeping an eye on conditions when one of these asset classes outperforms. When they're all telling the same story at once, it'd be wise to get yourself prepared and probably quickly.

This week's list of ETFs to have on your radar plays on this defensive shift theme. Given the Fed's endless support of this market, there's certainly a chance that the trillions of dollars that have been dumped into the economy are able to push asset prices higher from here, but the signs here are strong that investors are becoming more defensive and seeking safe haven assets.

Here are three ETFs I'm going to be watching this week and the narratives that go along with them.

AGFiQ U.S. Market Neutral Anti-Beta ETF (BTAL)

When it comes to equity hedges, I've mentioned BTAL several times. It's a long/short strategy that goes long in low volatility stocks and shorts high beta ones. In essence, BTAL will generate gains whenever low vol outperforms high vol regardless of whether the overall market is heading up or down.

During bull markets, high beta often leads low volatility, so BTAL could be expected to underperform in these environments as we've seen over the past month.

In down markets, however, is where BTAL earns it's keep. Since the beginning of June, we've seen BTAL in a slow uptrend as high beta begins to lag. In fact, the basing pattern has mostly been in place since March, which would indicate that the bull market has at least taken a pause here.

If you're looking for some downside protection in anticipation of a correction, overweighting low volatility stocks would certainly be a reasonable strategy. If you want to try to capture some gains in a down market, BTAL could be your choice.

Invesco S&P 500 Equal Weight Utilities ETF (RYU)

Here's another strategy has establishing a little downside protection - overweighting utilities. Even as the S&P 500 has been pushing higher, utilities have mostly been moving sideways or even slightly down since April. Even as other defensive asset classes have been outperforming recently, utilities have struggled to follow suit.

That is until last week when the utilities sector gained nearly 3% and outperformed the S&P 500 by almost 4%. Finally, utilities have begun confirming what Treasuries and lagging small-caps have been telling us.

Utilities have some room to run and I think they could be positioned to outperform here, especially if the debt ceiling fight at the end of the month turns ugly. The one hiccup could be if investors begin pivoting back to growth over defensives if there are concerns over peaking growth. The theme of "a recovery but a slowing recovery" has made large-cap growth a popular landing spot, but I think even that trade could begin breaking down.

The Utilities Select Sector SPDR ETF (XLU) is easily the largest in this area, but it's a little too top heavy in names, such as NextEra Energy, Duke Energy and the Southern Company, for my liking. That's why I prefer the equal-weight RYU instead.

Vanguard FTSE Emerging Markets ETF (VWO)

I've been a long-term bull on emerging markets for a while now. The argument is pretty easy to make - above average growth expectations and low valuations make the risk/reward proposition attractive, especially having underperformed for years.

The short-term narrative, however, just isn't catching on. Several countries are still struggling with COVID outbreaks and even though higher growth is expected from these areas, investors are favoring more mature, large companies for their growth exposure. The rebounding dollar as investors shift defensively isn't helping.

Emerging markets are slightly up on the year, but it's mostly been a sideways journey. If you're willing to hold for the next decade, I don't think you'll be disappointed by investing in emerging markets. If you're looking at the environment over just the remainder of 2021 and into 2022, I'm having trouble thinking that emerging markets are going to lead.

Chart of the Week

If you use the S&P 500 as your gauge for how the equity markets are doing, you’re missing out on what the rest of the market is saying. As mentioned above, the Russell 2000 has trailed the S&P 500 by more than 15% since the beginning of March. This is far from what you might expect to see during a period of economic expansion.

If you take this in conjunction with the fact that Treasuries are posting strong gains, commodities prices are tumbling and utilities have begun outperforming again, you’ve got all the signs that there is trouble brewing the U.S. equity markets.

It would be wise to at least consider taking some risk off the table here.