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ETF Strategies to Follow If Fed Cuts Rate

Sweta Killa

After a May swoon, the U.S. stock market has rallied this month on high hopes of monetary easing policy. This is especially true as the Fed has hinted at a rate cut this year if needed, given that aggravating trade disputes have raised fears of global growth slowdown.

However, a rate cut is not expected this month. Several Fed watchers expect Chairman Jerome Powell to drop the word “patient” from his statement and open the door to a cut next month (read: ETFs Set to Soar on Rate Cuts Signal).

Is Rate Cut Justified?

Bouts of weak data spurred speculation about interest rate cuts. In particular, the ISM’s manufacturing PMI fell to the lowest level since 2016 while IHS Markit US manufacturing PMI came in even worse, declining to levels not seen in a decade. Also, the U.S. economy added 75,000 jobs in May. This is the second time in four months that job growth hit less than the 1,00,000 mark. Wage growth rate also slowed down last month. Inflation ticked up just 0.1% in May following a 0.3% increase in the previous month.

Further, the bond market is signaling a recession with the inversion of the yield curve, in which short-term interest rates are higher than the long-term ones. All these data indicate a softening economy.

Apart from domestic fundamentals, global trends are on the weak side with the escalation in trade tension between the United States and China that has raised the global growth fears. Factory activity also contracted in Europe and Asia last month, compelling central banks across the globe to roll out more stimulus. The World Bank early this month slashed its global growth outlook from 2.9% projected in January to 2.6% -- the slowest growth in three years -- citing trade conflicts, financial strains and unexpectedly sharp slowdowns in wealthier countries.

If the Fed cuts interest rates, investors should follow some strategies in order to gain from the future trend. Here are some of the strategies that could prove extremely beneficial for ETF investors in the coming months:

Focus on Rate-Sensitive Sectors

Rate-sensitive sectors such as utilities and real estate will be the biggest beneficiaries, given their sensitivity to interest rates. Additionally, global headwinds such as still unresolved trade tensions, Brexit, geopolitical tensions and global growth worries are making investors jittery, raising the appeal for the stocks of these sectors. This is because these often act as a safe haven in times of market turbulence and offer higher returns due to their outsized yields (read: Forget Trade Fears, Invest in Defensive Sector ETFs).

While there are several options in these sectors, the most popular are Vanguard Real Estate ETF VNQ, Schwab US REIT ETF SCHH, Utilities Select Sector SPDR XLU, and Vanguard Utilities ETF VPU. All these funds have a Zacks ETF Rank #3 (Hold).

Low-Rate Friendly Sectors

Decline in interest rates will lead to strong optimism in the homebuilder space, which is rallying on a decline in mortgage rates and slower home price growth that have made housing more affordable. Additionally, auto stocks will also benefit from a rate cut as it will make auto loans cheaper and drive sales. But tariff threats in the industry are looming large, which might weigh on the sector and offset the low-rate advantage.

Given this, SPDR S&P Homebuilders ETF XHB, Invesco Dynamic Building & Construction ETF PKB and First Trust NASDAQ Global Auto Index CARZ could be good bets. All these have a Zacks ETF Rank #3 (read: ETFs to Win After Soft May Jobs Data).

Emphasis on High-Yield Dividend Products

The falling rates will lead to investors’ drive for higher yields, thereby raising the appeal for dividend investing. While there are several dividend ETFs, honing in on the top-ranked high-yielding products seem to be good picks. Some of these are Vanguard High Dividend Yield ETF VYM, iShares Core High Dividend ETF HDV and SPDR Portfolio S&P 500 High Dividend ETF SPYD. VYM and SPYD have a Zacks ETF Rank #2 (Buy), while HDV has a Zacks ETF Rank #1 (Strong Buy).

Invest in Emerging Markets

Rate cut will be a boon to emerging markets though trade war tensions will remain headwinds. Lower rates will push the U.S. dollar down, pulling in more capital into the emerging markets. ETFs like iShares MSCI Emerging Markets ETF EEM, Vanguard FTSE Emerging Markets ETF VWO, and iShares Core MSCI Emerging Markets ETF IEMG could be compelling choices. These have a Zacks ETF Rank #3 (read: Best ETF Ideas for the Second Half of 2019).

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