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Best ETF Strategies for a Hawkish Fed

Sanghamitra Saha
Tilly's (TLYS) closed the most recent trading day at $16.18, moving -0.98% from the previous trading session.

Having waited long enough, the Fed turned super-hawkish in its just-concluded September meeting. Though the central bank came to terms with all inflation worries, it surprised the investment world by giving hawkish signals (read: Should You Play These ETF Strategies as Fed Meets?).

The Fed announced on Wednesday that it will start winding down its mammoth $4.5-trillion balance sheet of Treasury securities and mortgage-backed assets. The process will start with a decrease of up to $10 billion a month and reach $50 billion a month by next September. The Fed set an October target for the beginning of the process. As expected, the Fed left the benchmark interest rate intact in the range of 1 to 1.25%.

While these moves were expected, what surprised the market was “the central bank’s intention to press ahead with another rate hike this year and three more in 2018”, as per Bloomberg. Many market watchers previously thought that the Fed won’t practice two tightening policies simultaneously and a raft of weak inflation data earlier this year might discourage it from hiking rates too quickly.

The Fed chair believes that the ongoing strength of the economy and a tight labor market would eventually cement inflation. After all, “household spending has been expanding at a moderate   rate, and growth in business fixed investment has picked up in recent quarters.” But she also pointed to the possibility of changes in the planned course if things turn worse.

Fed Projections

The median estimate for economic growth in 2017 was upped to 2.4% from 2.2% projected in June, while the core PCE inflation estimate dropped to 1.5% from 1.7% in June. Projections for unemployment rate and the Federal funds rate stayed same at 4.3% and 1.4%, respectively (read: Here's an ETF to "Make America Great Again").

Market Impact

ETFs for the key U.S. equity gauges like SPDR S&P 500 ETF SPY and SPDR Dow Jones Industrial Average ETF DIA added about 0.04% and 0.1%, respectively, on Sep 20. PowerShares QQQ ETF QQQ lost about 0.3%, but all the three ETFs were down after hours.

Yields of the benchmark 10-year U.S. Treasury jumped 4 bps to 2.28% on Sep 20, 2017 from the day before and the greenback gained too. PowerShares DB US Dollar Bullish ETF UUP added about 0.8% on Sep 20.

What Should be Your ETF Strategies?

If the third-quarter earnings season comes out well, we do not expect extreme volatility in the market. Plus, the Wall Street is about to step into its best period of the year – the fourth quarter. The holiday season should also give a lift to the market.

Still, simultaneous policy tightening may dismantle some market complacency. After all, rise in rates will surely leave an adverse impact on Americans’ pockets and consumer spending. So, it is better to go for some quality and wining picks in this kind of market.

Bet on Banks

Along with Goldman, we too believe that bank stocks are good bets now in a rising-rate environment. PowerShares KBW Regional Banking ETF KBWR gained about 1.2% on Sep 20 (read: Hot Areas of Last Week and Their ETFs).

Dump Rate-Sensitive Sectors

Needless to say, sectors that perform well in a low-interest-rate environment and offer higher yield, may falter when rates rise. Since real estate and utilities are such sectors, it is better to go for inverse REIT or utility ETFs. Vanguard REIT ETF VNQ and Utilities Select Sector SPDR ETF XLU already lost about 0.2% and 0.8%, respectively, on Sep 20. ProShares Short Real Estate REK and ProShares UltraShort Utilities SDP are such inverse ETFs that could be winners in a rising-rate environment.

Land on Quality Picks

High-quality companies with high earnings growth, or low leverage or that consistently deliver better risk-adjusted returns than the broader market are good picks now.

FlexShares Quality Dividend ETF QDF added 0.1% on Sep 20 and yields about 2.85%. Barron’s 400 ETF BFOR, which looks to select high performing U.S. stocks based on four fundamental factors--growth, valuation, profitability and cash flow, added 0.2% on Sep 20. VanEck Vectors Morningstar Wide Moat ETF MOAT, which offers exposure to the 20 most-attractively priced companies with sustainable competitive advantages, also gained 0.1% on Sep 20.

Dividend Aristocrat ETFs  

Companies that raise dividends consistently can be opportune bets.For example,iShares Core Dividend Growth ETF DGRO and SPDR S&P Dividend ETF SDY added more than 0.1% each on Sep 20 (read: An Investor's Guide to Dividend Aristocrat ETFs).

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SPDR-DJ IND AVG (DIA): ETF Research Reports
 
NASDAQ-100 SHRS (QQQ): ETF Research Reports
 
SPDR-SP 500 TR (SPY): ETF Research Reports
 
PWRSH-DB US$ BU (UUP): ETF Research Reports
 
VIPERS-REIT (VNQ): ETF Research Reports
 
SPDR-UTIL SELS (XLU): ETF Research Reports
 
ISHRS-CORE DG (DGRO): ETF Research Reports
 
SPDR-SP DIV ETF (SDY): ETF Research Reports
 
PWRSH-KBW RBP (KBWR): ETF Research Reports
 
PRO-ULS UTIL (SDP): ETF Research Reports
 
PRO-SH REAL EST (REK): ETF Research Reports
 
VANECK-MS WD MT (MOAT): ETF Research Reports
 
FLEXS-QLTY DIV (QDF): ETF Research Reports
 
BARRONS-400 ETF (BFOR): ETF Research Reports
 
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