Two Federal Reserve officials recently said that the U.S. economy is advancing steadily. Though the labor market still has room for improvement, inflation is running high and may compel the Fed to taper QE.
Atlanta Federal Reserve Bank President Raphael Bostic said he is eyeing the fourth quarter for the start of a bond-purchase taper but can support an even earlier start if the job market records faster improvement.
Moreover, both Bostic and Richmond Fed President Tom Barkin believe inflation has already hit the Fed's 2% goal, according to their separate assessments ,as quoted on the source. And this is where the Fed could rely on for policy tightening.
Will We See the Repeat of 2013's Taper-Tantrum Ahead?
Such rising rate worries have similarities with the taper tantrum we noticed in 2013. That time the selloff happened due to the Fed’s decision to wrap up the QE measure in a phased manner. Back then, the U.S. 10-year Treasury yields had jumped from 1.60% to about 3% on such fear.
U.S. benchmark Treasury yields started the month with 1.20% while it ended Aug 9 at 1.33%. If QE taper starts, there could be a rout in the bond market with selloffs expected to take place for growth stocks while value stocks and economic reopening-friendly stocks should see growth momentum.
Notably, the tech-heavy Nasdaq won during the pandemic-ridden 2020 on low rates and rising rates could now be wreaking havoc on the segment. High growth companies’ value normally relies on expected earnings growth and as long-term yields rise, it lowers the present value of companies’ future earnings.
Against this backdrop, below we highlight a few ETFs that could be the winning picks if the Fed tapers soon.
ETFs in Focus
iShares Russell 2000 Value ETF IWN
Small-caps stocks tend to outperform in a growing domestic economy. Rapid vaccination and stimulus rollout are great positives for the segment. Honing in on the value spectrum in the small-cap segment would be a great idea amid taper tantrum. Value stocks tend to perform in a rising rate environment. This is especially true given the fund IWN is heavy on Financials – a sector that is a great beneficiary of rising rates.
Invesco QQQ Trust (QQQ)
The tech-heavy Nasdaq calls for a great long-term investment story. The fund houses the world’s most cash-rich stocks like Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN). So, even if growth stocks in general depend on cheap money, rising rate worries are more of a threat for smaller tech companies. Such cash-rich bellwethers wouldn’t feel the heat that much. Rather these will continue to focus on the growing emergence of disruptive technologies.
Vanguard High Dividend Yield ETF (VYM)
With the 10-year Treasury yield crossing the S&P 500 dividend, income-loving investors would definitely look for other better options. VYM yields 2.75% currently. Plus, the dividend payout scenario has also improved within corporate America.
iShares U.S. Regional Banks ETF (IAT)
As regional banks fare well in a steepening yield curve environment, IAT has chances of gaining ahead. As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve will earn more on lending and pay less on deposits, thereby leading to a wider spread. This will expand net margins and increase banks’ profits.
Invesco Senior Loan ETF (BKLN)
Senior loans are floating rate instruments and thus pay a spread over the benchmark rate like LIBOR, which help in eliminating interest rate risk. This is because when interest rate rises, coupons on senior loans increase while the value of the bonds decline, keeping investments stable. Since these loans are issued by companies with below investment grade credit ratings, they usually pay yields to compensate for the risk.
Given this, senior loans and the related ETFs offer higher yields along with protection against any interest rate rise, making these ideal investments. Further, they carry lower credit risk than most other assets, with a similar level of yield and have low correlations with the other asset classes. Hence, investors can definitely play BKLN, which yields 3.21% annually.
iShares TIPS Bond ETF TIP
Since inflation is rising, inflation protected TIPS ETF could be a winning bet. The underlying Bloomberg Barclays (LON:BARC) U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) measures the performance of the inflation-protected public obligations of the U.S. Treasury. The fund yields 3.11% annually (read: Why This is The Time for TIPS ETFs).
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Invesco QQQ (QQQ): ETF Research Reports
iShares TIPS Bond ETF (TIP): ETF Research Reports
iShares Russell 2000 Value ETF (IWN): ETF Research Reports
Vanguard High Dividend Yield ETF (VYM): ETF Research Reports
iShares U.S. Regional Banks ETF (IAT): ETF Research Reports
Invesco Senior Loan ETF (BKLN): ETF Research Reports
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