The possibility of the Federal Reserve slowing its bond purchasing program sent interest rates rocketing in May. Rate-sensitive assets — dividend stocks, REITs, MLPs, preferreds, muni bonds — all began to depreciate in value. By the end of the month, even common stocks began to stammer.
Here on the first trading day of June, however, the Institute of Supply Management (ISM) offered up its assessment of U.S. manufacturers. Not only did the manufacturing sector shrink for the first time since November, the data point represented the worst reading in 4 years.
In the same manner that bad news continues to be good news, the Dow and the S&P 500 surged higher. Clearly, there isn’t a snowball’s chance in Death Valley that the Federal Reserve will taper its quantitative easing (QE). On the other hand, what should ETF investors take away from the clear evidence that economic output is waning?
|Are Defensive Stocks Really Finished?|
|6/3/2013||1 Month||3 Month|
|Popular Non-Cyclical Stock ETFs|
|iShares DJ Consumer Staples/Goods (IYK)||0.7%||0.6%||7.1%|
|Market Vectors Pharmaceuticals (PPH)||0.6%||2.0%||8.8%|
|SPDR Select Sector Health Care (XLV)||0.6%||2.2%||10.4%|
|iShares DJ Telecom (IYZ)||0.1%||-1.3%||10.4%|
|Popular Cyclical Stock ETFs|
|iShares DJ Materials (IYM)||0.4%||4.7%||5.0%|
|SPDR Select Industrials (XLI)||0.3%||5.5%||7.5%|
|iShares DJ Transportation (IYT)||0.0%||3.4%||4.5%|
|SPDR KBW Bank ETF (KBE)||-0.4%||7.3%||8.1%|
Less than a week ago, scores of commentators began discussing the best way to invest in the current environment. They advised shifting from non-cyclical stock assets to cyclical stocks like those in the banking and tech sectors. The reasoning? Not only did the month-over-month numbers show evidence of sector rotation, but rising rates were supposedly a sign of a strengthening U.S. economy.
Today, however, there will be less talk of a resilient economic backdrop and more talk of a summertime slowdown. And until the Fed fully commits to the same amount of QE, or perhaps a bump higher in the monthly bond purchasing, stock assets might struggle for definitive direction as well.
Granted, SPDR Industrials (XLI) and SPDR Materials (XLB) were phenomenal in May. Financial shares could do no wrong. And “”Risk On” was in complete control of the cockpit.
On the other hand, can high beta, higher risk assets prosper if the world economy continues to falter? The European Union entered its 6th consecutive recessionary quarter, India reported its slowest gross domestic product (GDP) in a decade, manufacturing in China is contracting and Japan’s rapid currency devaluation is creating sovereign debt concerns.
The solution remains the same as it has for most of 2013. Specifically, ETFs less tethered to economic uncertainty are better able to ride out increasing market volatility. Funds like SPDR Select Health Care (XLV) and iShares DJ Consumer Goods (Staples) are providing equal or better reward for less risk.
In addition, dividend investing did not die with its setback in May. As long as the Fed recommits to its QE (and let’s face it… tapering talk was little more than a trial balloon), high dividend equity payers from the non-cyclical sectors will remain desirable. For instance, iShares High Dividend Equity (HDV) focuses largely on health care corporations and telecom. Moreover, this exchange-traded tracker appears to have strong support at its 50-day trendline.