Home etftrends.com VettaFi Voices On: Risk Management in an Uncertain Economy

VettaFi Voices On: Risk Management in an Uncertain Economy

Hello, VettaFi Voices! Whenever I read about the economy in 2023, the one word that comes up repeatedly in various forms is “uncertain.” Now seems a good time to ask: How do you see risk management, and what do you think is an effective way to manage risk at a time when everything is … uncertain?

Todd Rosenbluth, VettaFi Director of Research: VettaFi hosted a webcast in September with State Street Global Advisors. We asked what advisors were most concerned about. The top two choices were a recession (34%) and market valuations (33%). These were far ahead of inflation, finding income, climate change, and geopolitical tensions. Uncertainty remains high.

Heather Bell, VettaFi Managing Editor: It does seem like the economic theme for 2023.

ETFs for Uncertain Times

Rosenbluth: There’s a wide range of ETFs to help if you are concerned the market will weaken after a strong run due to the economy. There are lower volatility ETFs like the Invesco S&P 500 Low Volatility ETF (SPLV) and the iShares MSCI USA Min Vol Factor ETF (USMV) that own the least risky stocks with the broader market. Or the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) and the FlexShares US Quality Low Volatility Index Fund (QLV), which combines low vol with other more defensive factors like dividends or quality.

If you want quality or high dividends alone, that could work with ETFs like the iShares MSCI USA Quality Factor ETF (QUAL) and the VictoryShares Free Cash Flow ETF (VFLO), or the Vanguard High Dividend Yield Index ETF (VYM) and the ALPS Sector Dividend Dogs ETF (SDOG).

Time for Derivatives-Based Strategies?

Then there’s the defined outcome suites of ETFs that feature funds like the Innovator U.S. Equity Buffer ETF – October (BOCT) and the FT Cboe Vest U.S. Equity Buffer ETF- October (FOCT), which limit the downside in exchange for capping the upside of the S&P 500. These generally have a 12-month time horizon between resets, and each issuer tends to offer a full suite of defined outcome ETFs with reset dates for each month. But, of course, they can be held for longer or shorter periods.

There’s also the covered call universe of ETFs like the JPMorgan Equity Premium Income ETF (JEPI), the Global X S&P 500 Covered Call ETF (XYLD), the Amplify CWP Enhanced Dividend Income ETF (DIVO), and the NEOS S&P 500 High Income ETF (SPYI) that use options to enhance the income of owning individual stocks. These all have different but similar approaches. And there’s of course a growing number of actively managed large-cap ETFs that can shift to a more defensive posture or raise some cash based on management discretion. I will refrain from listing these as I might reach the ticker limit.

I’d further note that the iMGP DBi Managed Futures Strategy ETF (DBMF) has seen inflows in the past month.

Jen Nash, what does the latest economic data tell you about a potential recession?

A Different Kind of Recession

Jen Nash, VettaFi economic and market research analyst: A lot of voices in the media right now are giving conflicting views regarding a possible recession. It seems that the potential of recession remains… uncertain (there’s that word again!).

When I look at the data, I believe there is a more likely chance of a recession occurring than not. The inverted yield curve, the Conference Board Leading Economic Indicator declining for the past year and a half, the recent uptick in the unemployment rate to 3.8%, the declines in consumer confidence and consumer sentiment over the last few months, not to mention what is going on in the housing market right now, with a decline in housing starts (lowest level since 2020) and new home sales.

All of those indicators seem to be warning of a recession ahead. However, there is a lot of talk of a rolling recession, where different parts of the economy contract and recover at different times. And this could definitely describe where we are headed

Bell: Jen, have we had anything like that before?

Nash: The term “rolling recession” has gained popularity over the last year or so. That’s because a lot of the data seemed to imply that’s where we were. We’ve had strong employment and robust consumer spending. That happened even when the housing market suffered and the tech industry laid off thousands of workers. According to this article, this is not the first time the U.S. has seen a possible recession like this. The article mentions other rolling recessions: one in the 1960s and another in 2016.

A Looming Government Shutdown

Rosenbluth: I was previously talking equity ETFs, but the iShares 20+ Year Treasury Bond ETF (TLT), which is what some people flock to during times of uncertainty, has seen more than $700 million of net inflows in the past week. Other less-rate-sensitive Treasury ETFs like the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL) and the iShares 1-3 Year Treasury Bond ETF (SHY) have seen strong inflows too. Jen’s touching on the economic data, but we are likely to have a government shutdown soon after people read this. That is, unless the Republicans in the House don’t step on the brakes with the cliff approaching.

Nash: The government shutdown will obviously only add to the uncertainty, as a handful of key reports regarding employment and inflation will be disrupted. The Fed is on record of being data driven, but without the data from these essential reports, their next meeting on November 1 could get a lot more complicated.

Rosenbluth: Stacey Morris, in a recent VettaFi equity symposium, we heard advisors are favoring energy investments among sectors. High oil prices likely play a role here. Are energy infrastructure stocks found in AMLP a better alternative to Exxon and Chevron for those uncertain investors?

Energy Investments Could Help

Stacey Morris, VettaFi head of energy research: That’s right, Todd. Investors have been constructive on energy, which fits with higher oil prices and strong performance in recent months. Energy infrastructure provides more defensive energy exposure because companies largely provide services for fees. Investors can want energy exposure but also may worry about a reversal in oil prices.

For them, energy infrastructure can be a great option that also provides attractive income. If investors are bullish on oil prices and want more commodity price exposure, they are best off looking at individual oil and gas producers or ETFs that focus on those companies. Those vehicles would likely give more upside in a continued oil rally than Exxon or Chevron.

Rosenbluth: To be clear, the Alerian MLP ETF (AMLP) would be an example of an energy infrastructure ETF. The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) would be an example of a higher-risk but higher-reward oil & gas production and exploration ETF.

Consumer Perspectives

Roxanna Islam Swan, VettaFi associate director of research: I actually talked about this topic a little bit on Tuesday on Schwab. It’s definitely a weird time, and we’re finally starting to see defensive sectors become more attractive. We’re starting to see some signs of a slowdown, like Jen mentioned.

It’s so odd because consumer confidence has reached a four-month low, but we still had a relatively strong summer. It included a successful Prime Day, big box office weekends, and people spending hundreds to thousands of dollars on Taylor Swift and Beyonce tickets. It’s like the brakes need to be pressed, but consumers aren’t quite ready yet. A lot of earnings results lately have been showing there is a slowdown in individual companies. That’s especially true for those that depend heavily on consumer spending. However, it hasn’t necessarily shown up yet on a broader sector basis.

The Consumer Discretionary Select Sector SPDR Fund (XLY) is still proving that consumer discretionary is one of the most exciting sectors outside of tech and communications. But it’s been driven by large-cap names like Tesla and Amazon, in addition to service-related sectors — not goods.

On the other hand, the Consumer Staples Select Sector SPDR Fund (XLP) (staples) is not that exciting yet. But Costco (its second largest holding) released earnings earlier this week and had a decent beat. It’s generally a more recession-proof stock since it benefits from consumers who are looking to save money. Memberships were up almost 8% year over year. There’s some broader read-throughs there for the sector. Maybe it’s time to start thinking about reallocating or increasing exposure into more recession-proof areas while prices are still cheap.

Rosenbluth: Thank goodness you got Taylor Swift in here. This is her year!

And we now have music ecosystem ETFs like the MUSQ Global Music Industry ETF (MUSQ)

Uncertainty Is the Norm

Zeno Mercer, senior research analyst at VettaFi: I think what’s most interesting is that, truly, the future (and the economy) is always uncertain, but how much people are focusing on the uncertainty is what changes. Uncertainty is the status quo (and to be fair, the VIX is pretty settled right now, historically, but is up 20% over the past month).

We had several years of consumer boom and transition as the great COVID-19 migration occurred. People upgraded and bought home devices for the first time, further quantitative easing in the U.S., and so on. Now, we have tightening, inflation, consumer and corporate credit climbing, and delinquencies rising. Our debt levels are sky-rocketing. Also, there are truly multiple layers of inefficiency and spending mismanagement at the government level (including healthcare administration burden).

Potential Bright Spots

On the flip side, there has been a big government push for improving and reshoring key industries such as energy (battery and solar) and semiconductor manufacturing powered by the Inflation Reduction Act and the CHIPS act, respectively. Ideally, investments in AI and automation will not only improve government function and its role, but start to reduce debt levels.

Additionally, we’re still seeing persistent labor shortages in warehouse and manufacturing jobs that are driving increased investment in automation solutions. We’re looking at Robotics and AI as both an early-innings growth story and a techno-hedge versus recession. We could see spending on consumer devices and services slow (such as Apple iPhones). However, from a cyclical perspective, there’s more resiliency in the robotics space. It’s predicted to continue to grow as an overall percentage of GDP (regardless of where it is directionally headed in the near-term).

Rosenbluth: The ROBO Global Robotics & Automation Index ETF (ROBO) is now tracking a VettaFi family index. However, the robotics and AI trend you’re referring to, Zeno, also impacts ETFs like the iShares Robotics and Artificial Intelligence Multisector ETF (IRBO) and the Global X Robotics & Artificial Intelligence ETF (BOTZ). These thematic funds are tied to other index providers.

For more news, information, and analysis, visit VettaFi | ETF Trends.

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