5 ETF Strategies to Follow in Q4

Wall Street has shown a remarkable rally this year. The artificial intelligence (AI) craze and rate-cut optimism have been the major driving factors amid recession fears, geopolitical tensions and the sell-off in tech stocks that weighed on investors’ confidence. 

After holding the rates at a 23-year high for 14 consecutive months since July 2023, Federal Reserve Chair Jerome Powell kicked off the new rate cycle era by initiating a 50-basis point (bp) cut in interest rates. This marked the first rate cut since 2020 to address slowing economic growth and showed greater confidence that inflation is moving sustainably toward the 2% target.

The central bank projects two more rate cuts of 50 bps in its final two meetings this year due in November and December. It also indicates another 100-bp rate cut next year and a 50-bp reduction in 2026, which means four rate cuts in 2025 and two in 2026. However, the latest blockbuster jobs report regained investors’ confidence in the economy's health and pushed back the prospect of rate cuts in November. 

The jobs data showed the biggest jump in six months in September, a fall in the unemployment rate and solid wage increases, pointing to a resilient economy. The United States added 254,000 jobs last month, up from a revised 159,000 in August, and unemployment dipped to 4.1% from 4.2% in August. 

Meanwhile, the tensions in the Middle East intensified following Iran's missile attack on Israel. Iran launched about 200 ballistic missiles targeting Israel on Oct. 1, leading to growing fears of retaliation from Israel. The attack has accelerated tensions in the Middle East, leading to risk-off trade. Additionally, next month's election in the United States is expected to heighten market volatility. 

Given the current market environment, we have highlighted some investing strategies that could prove to be extremely beneficial for investors:

Bet on Rate-Sensitive Sectors

Low rates reduce the cost of borrowing, which is often needed to finance the expansion of companies, thereby driving growth. This can positively impact sectors like real estate, consumer discretionary and financial services, which are typically sensitive to interest rate changes. 

In real estate, lower rates can boost housing market activity by making mortgages more affordable. For consumer discretionary sectors, reduced borrowing costs can lead to increased consumer spending. In the financial sector, while lower rates can compress net interest margins for banks, they can also encourage lending and potentially lead to increased consumer and business loan activity (read: 5 Sector ETFs Scaling New Highs on Fed Rate Cuts).

Investors could load up stocks in any of these sectors through ETFs like Vanguard Real Estate ETF VNQ, Consumer Discretionary Select Sector SPDR Fund XLY, iShares U.S. Home Construction ETF ITB, SPDR S&P Telecom ETF XTL and Financial Select Sector SPDR Fund XLF. XLF has a Zacks ETF Rank #1 (Strong Buy), while the rest have a Zacks ETF Rank #3 (Hold).

Add Value to Your Portfolio

Amid the current woes, value investing seems appealing to investors. This is because value stocks, which have strong fundamentals — earnings, dividends, book value and cash flow — and trade below their intrinsic value, will likely benefit from growth in the economy and simultaneously from bouts of stock market volatility.

Value stocks seek to capitalize on the inefficiencies in the market and have the potential to deliver higher returns with lower volatility compared with their growth and blend counterparts. These are less susceptible to the trending markets, and their dividend payouts offer safety in times of market turbulence. While most of the funds in the value space seem excellent choices, Vanguard Value ETF VTV, iShares Russell 1000 Value ETF IWD and Schwab U.S. Large-Cap Value ETF SCHV have a Zacks ETF Rank #1 (read: Bull Run at Risk? Shield Your Portfolio With These ETFs).

Bet on Quality

Quality investing seems to be a solid bet. Quality stocks possess a sustainable competitive advantage and demonstrate consistent growth, profitability and operational excellence over time. These stocks are rich in value characteristics with a healthy balance sheet, high return on capital, low volatility, elevated margins and a track of stable or rising sales and earnings growth. 

Quality products thus reduce volatility when compared to plain vanilla funds and hold up rather well during market swings. Further, academic research shows that high-quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term. 

Among the most popular are iShares MSCI USA Quality Factor ETF QUAL, Invesco S&P 500 Quality ETF SPHQ, JPMorgan U.S. Quality Factor ETF JQUA.

Focus on Low Volatility

Low-volatility ETFs have the potential to outpace the broader market in an uncertain environment, providing significant protection to the portfolio. This is because these funds include more stable stocks that have experienced the least price movement in their portfolio. Further, these allocate more to defensive sectors with a higher distribution yield than the broader markets. ETFs like iShares Edge MSCI Min Vol USA ETF USMV and Invesco S&P 500 Low Volatility ETF SPLV could be compelling choices. These have a Zacks ETF Rank #3 (Hold).

Emphasis on Dividends

Dividend-paying securities are the major sources of consistent income for investors when returns from the equity market are at risk. This is especially true as these stocks offer the best of both worlds — safety in the form of payouts and stability in the form of mature companies that are less volatile to the large swings in stock prices. The companies that pay dividends generally act as a hedge against economic uncertainty and provide downside protection by offering outsized payouts or sizable yields on a regular basis (read: Best-Performing Dividend ETFs of the First Nine Months of 2024).

In particular, ETFs with stocks having a strong history of dividend growth seem to be good picks. Vanguard Dividend Appreciation ETF VIG and iShares Core Dividend Growth ETF DGRO have a Zacks ETF Rank #1 or #2 (Buy).

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