Bet on These Quality ETFs as March Hike is Most Likely

Sanghamitra Saha

Updated March 15, 2017 at 11:09 a.m.

After a superb Trump rally since the November election, the market seems to have taken a step back. Rising rate worries, overvaluation fears in the stock market, decline in energy shares thanks to surging U.S. crude output, and recession concerns on real estate probably called for this correction.

Big U.S. ETFs including the S&P 500-based SPY haslost 0.8%,Dow Jones Industrial Average-based DIA has shed about 1% while Nasdaq-100 based QQQ hasnudged up about 0.1% so far this month (as of March 14, 2017).

Let’s delve a little deeper:

Likely Fed Rate Hike

The Fed has already met and most investors are expecting the third-rate hike in a decade. Possibilities of a rate hike now hovers at around 93%, according to CME futures trading. In December, 11 of 17 members of the Fed's policy committee penciled in a minimum of three rate hikes in 2017, and five members went even more hawkish expecting at least four.

Hawkish tone from a number of Fed officials including the chief Yellen of late triggered chances of faster hikes this year. Stabilization in the global economy with the U.S. staging a steady recovery, a solid labor market and a considerable pickup in inflation spurred their optimism (read: Doves Turn Hawks: 5 Fed-Proof Bond ETFs to Buy).

Chances of faster policy tightening took the yield on 10-year U.S. Treasury note to almost the highest level since 2014. Previously, the Fed could not hike its rock-bottom interest rates many times (though intended) due to an inclement financial backdrop. But 2017 is unlikely to repeat the story. A fiscal boost from Trump’s policy will likely support the economy and market to a large extent, which in turn should make the case easy for the Fed.

Having said that we would like to note that faster hikes may bring about a correction in an already lofty market. Gradual ceases in cheap dollar inflows may hit the market momentum. In particular, higher rates may result in lower consumer spending on a wide range of products including cars and houses. This in turn may hurt profitability across various segments, especially housing and business investment (read: Play These Stocks & ETFs If Fed Acts in March).

Overvaluation Fears Heighten

Overvaluation concerns also played a role in bringing down U.S. stocks. The S&P 500 is currently trading close to 18 times the expected earnings, against its long-term average of about 15 times (as per Reuters). Investor optimism touched a multi-year high, signaling a correction on any negative news (read: 5 Alternative ETFs to Avoid 'Cognitive Dissonance' in Market).

As per an analyst, “this is the most dangerous and overvalued stock market on record — worse than 2007, worse than 2000, even worse than 1929.” The source reports that “the total U.S. stock market is now valued at more than 150% of annual gross domestic product.”

Amid all the upheaval, volatility levels flared up, with iPath S&P 500 VIX ST Futures ETN VXX rising about 1.74% on March 14. These worries may keep the stock market volatile, and investors may find some protection in quality ETFs.

Quality stocks are generally rich in value characteristics like strong return on equity, low earnings variability, higher free cash margins and low debt-to-equity. While there are several options available in the space, we have highlighted a few that can be good short-term plays.

Quality ETFs in Focus

iShares Edge MSCI International Quality Factor ETF IQLT

The 284-stock fund gives exposure to large- and mid-cap developed international stocks with positive fundamentals like high return on equity, steady year-over-year earnings growth and low financial leverage. No stock accounts for more than 3.79% of the portfolio.

The $23-million fund is heavy on UK (19.29%), Switzerland (13.4%) and Japan (12.22%). Financials (22.50%) is the top sector of the fund followed by Industrials (13.82%) and Consumer Discretionary (11.32%). It charges 30 bps in fees.

WisdomTree International Hedged Quality Dividend Growth Fund IHDG

With the Fed preparing for faster policy tightening in the near term and most other developed economies pursuing easy money policies, a currency-hedged approach would be intriguing to set off the effect of a surging greenback.

IHDG serves this purpose. Moreover, IHDG takes care of investors’ income as the fund selects dividend-paying companies with growth features in the developed world ex U.S. and Canada. This Zacks ETF Rank #3 (Hold) ETF charges 58 bps in fees. UK (18.42%), the Netherlands (12.20%), Switzerland (12.02%) and Japan (10.89%) take the first four positions in the fund (see all Broad Developed World ETFs here).

FlexShares Quality Dividend Index Fund QDF

The 138-stock fund looks to provide exposure to the growth potential of U.S. securities while offering dividend. It puts about 18.7% focus on IT, followed by 13.5% on financials, 12.4% on industrials and 11.1% on consumer staples. The fund charges 37 bps in fees and yields 2.95% annually (as of March 14, 2017) (read: 6 Quality Dividend ETFs for Safety and Income).

O'Shares FTSE Europe Quality Dividend Hedged ETF OEUH

The 12.9-million fund looks to track the performance of high quality large and mid-cap equities across Europe that exhibit relatively low volatility and high dividend yields. Consumer goods and health care are the top two sectors. The fund yields about 8.24% annually (as of March 14, 2017). The fund has a Zacks ETF Rank #3 (see all European Equity ETFs here).

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Bet on These Quality ETFs as March Hike is Most Likely