How To Trade "Sell In May And Go Away" With ETFs

Though the U.S. bourses are hovering at their peak levels this year, they are easily lagging the broad market indices. This is especially true given that SPDR S&P 500 (AX:SPY) , tracking the S&P 500, has gained 7.1% this year versus 8.6% for the iShares MSCI ACWI ETF ACWI, targeting the global stock market (read: 5 Must-Watch ETFs as Nasdaq Hits 6,000).

The underperformance is likely to persist as seasonality is expected to play a huge role in pushing stocks down over the next six months as per the old adage “Sell in May and Go Away”. According to this investment saying, the stock market has a long history of weak performance during the summer months (May to October).

According to the latest study from Fidelity, the S&P 500 has delivered an average of just 2% gains from May to October in contrast to the average gains of 5% in the November–April period since 1928. Further, Sam Stovall, CFRA's chief investment strategist, has found that the election played an important role in this seasonal pattern. As for first-term presidents, Democrats averaged a 6.1% gain in May through October, while Republicans had a loss of 4% if history is any guide. In fact, first-term Republican Presidents see bigger 'sell in May' phenomena than Democrats.

Apart from the historical trend, feeble data, uncertain Trump’s pro-growth policies, lofty valuations, and geopolitical tensions will keep the returns at check going forward. However, the bullish sentiment for the stocks remains intact with U.S. consumer confidence hovering around a 16-year high (read: Buy-Ranked Mid-Cap ETFs for a Shaky Market).

The labor market has been on solid footing with the unemployment rate of 4.5% being at a 10-year low and the number of job creations outstripping growth in the working-age population. Additionally, investors are optimistic about first-quarter earnings, which seem robust with earnings and revenue growth for the period currently tracking above the other recent periods.

Against a mixed backdrop, it might be foolish to quit the stock market altogether. Instead, investors could rotate into the defensive sectors or low risk securities during this soft six-month period. As such, we have highlighted certain techniques for investors that could lead to a winning portfolio in such a rough time.

Invest in Defensive ETFs

Investors could try out safer avenues and rotate into defensive sectors, like utilities, healthcare, and consumer staples, which generally outperform during periods of low growth and high uncertainty. Additionally, this is a much better option than holding cash. Guggenheim Defensive Equity ETF (V:DEF) having Zacks ETF Rank of 3 or ‘Hold’ rating could be an excellent choice. This fund offers equal-weight exposure to all the stocks in the index, resulting in a more balanced and diversified portfolio. It helps the portfolio to better weather periods of volatility, while remaining positioned to take advantage of market upswings.

The other popular Zacks Rank #3 ETFs include Consumer Staples Select Sector SPDR Fund XLP, Vanguard Consumer Staples ETF VDC, Shares U.S. Consumer Goods ETF IYK, SPDR Health Care Select Sector (MX:XLV) SPDR Fund XLV, Vanguard Health Care ETF (AX:VHT) and iShares Dow Jones U.S. Healthcare Sector Index Fund IYH (read: Is Pain Ahead for Healthcare ETFs After Weak JNJ Q1?).

Focus on Low Volatility ETFs

As weak historical trends and volatility are expected to play foul in the stock market, low volatility ETFs appear sensible choices. This is because these have the potential to outpace the broader market in bearish-to-neutral market conditions, providing significant protection to the portfolio. These funds include more stable stocks that have experienced the least price movement in their portfolio. Further, these allocate more to defensive sectors that usually have a higher distribution yield than the broader markets (read: 3 Low Volatility ETFs to Buy if Global Tensions Flare Up).

While there are several options in the space, the two most popular ones are PowerShares S&P 500 Low Volatility Portfolio SPLV andiShares Edge MSCI Min Vol USA ETF USMV. Both funds have a Zacks ETF Rank of 2 or ‘Buy’ rating.

Focus on Low Beta ETFs

Low beta ETFs tend to exhibit greater levels of stability than their market-sensitive counterparts, and usually lose less when the market is crumbling. Though these have lower risks and lower returns, the funds are considered safe and resilient in rocky markets. Some of the funds that looks attractive are PowerShares Russell 1000 Low Beta Equal Weight Portfolio (TO:U) , First Trust Horizon Managed Volatility Domestic ETF (TO:U) and Fidelity Low Volatility Factor ETF FDLO (read: Lower Risk in Your Portfolio with These ETFs).

Hedge Portfolio with Inverse ETFs

Investors worried about the May swoon could also go short on stocks via ETFs. There are a number of inverse or leveraged inverse products currently available in the market that offer inverse (opposite) exposure to the various stock market indexes. While a leveraged play might be a risky option, inverse ETFs are interesting choices and provide hedging strategies in a bearish market.

Below are the most popular options in this space for each market cap. Each of these is from a single issuer – Proshares:

Short S&P 500 ETF SH and Short Dow30 DOG provide inverse exposure to large cap stocks. Short S&P 500 ETF offers the inverse performance of the S&P 500 while Short Dow30 targets the Dow Jones Industrial Average. Short QQQ ETF (AX:PSQ) seeks to deliver the opposite return of the Nasdaq 100 index (see: all Inverse Equity ETFs here).

Short MidCap400 MYY and Short Russell 2000 ETF RWM target the inverse performance of the mid and small cap segments of the broader U.S. market by tracking the S&P MidCap 400 and Russell 2000 indexes. Likewise, investors could also apply short strategies in different sectors through ETFs.

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SPDR-CONS STPL (XLP): ETF Research Reports

SPDR-SP 500 TR (SPY (NYSE:SPY)): ETF Research Reports

SPDR-HLTH CR (XLV): ETF Research Reports

VIPERS-HLTH CR (VHT): ETF Research Reports

ISHARS-US HLTHC (IYH): ETF Research Reports

ISHRS-MSCI ACWI (ACWI): ETF Research Reports

GUGG-DEF EQUITY (DEF): ETF Research Reports

PRO-SHRT QQQ (PSQ): ETF Research Reports

PRO-SHRT S&P500 (SH): ETF Research Reports

PRO-SHRT DOW30 (DOG): ETF Research Reports

VIPERS-CONS STA (VDC): ETF Research Reports

ISHARS-US CN NC (IYK): ETF Research Reports

POWERSH-SP5 LVP (SPLV): ETF Research Reports

FID-LV FACTOR (FDLO): ETF Research Reports

ISHARS-MS US MV (USMV): ETF Research Reports

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