The stock market has faced a torrid time lately. Many market participants were under the impression that an interest rate hike would re-direct the market towards a recovery.
Yet, matters seem more bearish than ever as a great deal of liquidity has shifted into cash investments, rather than the stock market. Nonetheless, modern portfolio diversification techniques allow investors to profit from the most torrid of times; here’s how to do it.
Understanding Factor Cycles
To benefit from market downturns, one must understand the market’s factor cycles, which are inextricably linked to economic cycles. According to Mark Carhart, Eugene Fama, and Kenneth French, stocks trend around growth, value, momentum, quality, and in some instances, dividend yield. Although some of these factors exhibit collinearity, most are observed as standalone cycles.
By examining the economic conditions since the start of the pandemic, it’s fair to say that we were initially in an expansionary economic environment with quantitative easing and technological innovation taking the forefront.
However, as time has progressed, inflation has surfaced, subsequently prompting economic policymakers to implement contractionary monetary policies with the inevitable result of stagnating real economic activity (including wages).
As a consequence, we’ve experienced a rotation out of growth stocks (down 5.75% year-over-year) and into high-quality/dividend-paying stocks (up 7.69% year-over-year).
Additionally, value stocks with inflation pass-through attributes have also outperformed the market (0.8% year-over-year). Lastly, momentum is always a prevalent factor in the stock market, meaning we’re likely to see a prolonged sell-off of growth assets.
I identified three investment options that I’m bullish on during these trying times. My screening process was based on the market’s proclivity to opt for low-volatility, quality, and value during bear markets. In addition, my picks are ETFs, meaning they possess the ability to diversify idiosyncratic risk.
iShares MSCI USA Quality Factor ETF
iShares MSCI USA Quality Factor ETF (QUAL) is managed by BlackRock (BLK) with the idea of investing in stocks that exhibit robust balance sheets, favorable return metrics, high-profitability, and low-volatility.
QUAL’s most prevalent holdings include Johnson & Johnson (JNJ), Apple (AAPL), Target (TGT), and Nike (NKE). The ETF is well diversified and rebalances passively with an expense ratio of merely 0.15%. Furthermore, QUAL pays a stable dividend with a forward yield of 1.25%, accompanied by a five-year growth rate of 2.73%.
Lastly, the ETF delivers what it promises to investors, as its three-year tracking error is 65.6% better off than its peers, which provides investors with a secure conviction play.
iShares MSCI USA Value Factor ETF
iShares MSCI USA Value Factor ETF (VLUE) is also a BlackRock-managed product with a mandate of investing in value-orientated stocks. Value stocks are known to pass-though inflation, as they’re supported by mature companies with high market shares.
A few of VLUE’s major holdings include AT&T (T), International Business Machines (IBM), and Ford (F). In addition, 9.44% of the ETF is exposed to the financial services sector, which could see it benefit from the rising interest rate environment.
VLUE’s expense ratio has an expense ratio of 0.15% and an annualized volatility of 11.82, setting it apart from its peers as a low-cost, safe-haven investment. In addition, VLUE sports a forward dividend yield of 2.96%, providing investors with lucrative income-generating properties.
Certain Wall Street analysts are optimistic about value stocks. For instance, Marko Kolanovic of JPMorgan (JPM) recently stated that investors should buy the dip in U.S. stocks as “higher bond yields should not be disruptive for equities, but rather support our call for a growth to value rotation.”
ProShares UltraPro Short QQQ
Shorting the market is extremely difficult. Thus, general long-only funds tend to outperform actively managed long/short funds. Nonetheless, ProShares UltraPro Short QQQ (SQQQ) provides lucrative downside protection by shorting Nasdaq-100 constituents.
Shorting Nasdaq stocks in the current growth stock bear market is certainly a lucrative strategy, especially considering the current economic climate.
The fund exhibits an expense ratio of 0.95% and is trading above its 10-, 50-, 100-, and 200-day moving averages, indicating that it’s on a strong momentum run.
Furthermore, SQQQ aligns with Morgan Stanley (MS) analyst Mike Wilson’s outlook. According to Wilson: “Anyone who tells you we are in a bull market has got a lot of explaining to do.”
Bottom Line
There are many ways for investors to protect themselves against market downturns and, in many instances, profit from such events.
There’s never been a bulletproof method for portfolio diversification. However, the assets mentioned in this article certainly provide evidence-based strategies.
Discover new investment ideas with data you can trust.
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