With a lot of uncertainty over interest rates still shadowing the markets, exchange traded fund investors should prepare for multiple outcomes.
Investors can plan for the three most probable outcomes of a Federal Reserve tightening, along with the possible ETF plays.
For starters, the yield curve could tighten with 3-year and 5-year rates moving up faster than long-term yields, which would indicate a healthy economy that is expanding without surging inflation, writes Mark Eicker, lead portfolio manager and CIO at Sterling Global Strategies, for Forbes.
In a healthy exit from the Fed’s loose policies, investors would stay long U.S. equities, like the SPDR S&P 500 ETF (SPY) , to capitalize on further growth and a non-hedged iShares MSCI EAFE ETF (EFA) once overseas rates begin to rise. Eicker also suggests mid-term duration bond ETFs for the fixed-income portfolio. The Guggenheim BulletShares 2024 Corporate Bond ETF (BSCO) provides a target-date maturity bond portfolio of corporate debt exposure. Additionally, for municipal tax-exempt income, the SPDR Nuveen Barclays Municipal Bond ETF (TFI) comes with a 7.48 year duration. [Muni Bond ETFs Look Attractive After Pullback]
If the yield curve steepens, every fixed-income asset will see higher rates but longer dated bonds will see yields rise the most, suggesting that the economy is quickly heating up. We would also experience a surge in inflation. The iShares TIPS Bond ETF (TIP) would help diminish the negative effects of rising inflationary pressures, and something like the iShares Floating Rate Bond ETF (FLOT) , which has an effective duration of 0.2 years, will help hedge against further rate risk. [Floating Rate ETFs for Rising Rates Protection]
Lastly, short-term rates could rise while long-term yields fall, which could point to a slowing U.S. economy as corporate borrowing costs rise. Consequently, high-yield options and high-quality long-duration bonds could outperform. For example, the Vanguard REIT ETF (VNQ) provides broad exposure to yield-generating real estate investment trusts – VNQ has a 3.5% 12-monthy yield. Moreover, the iShares 20+ Year Treasury Bond ETF (TLT) provides exposure to long-term U.S. debt, which would benefit the most as long-term bond yields fall.
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Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of SPY.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.