For much of the first half of 2023 — as the Federal Reserve worked hard to cool inflation while trying not to take the air out of the remarkably stable jobs market or dampen the enthusiasm of consumers who continued to spend — it seemed that Wall Street strategists everywhere were singing a consistent tune: Recession is coming. Recession is coming.
But then, as June turned to July, the inflation rate fell to a much improved 3%, unemployment remained at its five-decade low, and corporate earnings looked none too shabby, practically overnight the tune changed: Soft landing. Soft landing.
The mixed messages are enough to make an investor’s head spin. Particularly those investors who are not traders, but rather are in it for the long haul — using the markets to grow their money in order to achieve goals that are years (if not decades) away. These goals include the purchase of a home, college for the kids, and retirement. If you’re an investor like this (and most of us are), you shouldn’t be trying to time the market, says Jasmine Fan, CFA, and Vice President of iShares Investment Strategy. “What you need are tools that can help you understand different market dynamics at different times.”
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In the work that Fan and her colleagues do at iShares, they explore how different ETFs can be useful in helping to weather — or profit from — the sort of specific market forces that rear their heads from time to time. Here are a few scenarios to think about:
When The Fed Is Raising Interest Rates
When the Fed is in the middle of an interest rate-tightening cycle, it’s not unusual to find investors holding onto their cash. They do this for a number of reasons including “not fighting the Fed,” because these periods often produce mediocre market returns, as well as looking to capitalize on an eventual stock or bond rally when rates turn in the other direction. In recent months, we’ve been experiencing exactly that, perhaps exacerbated because of the inversion of the yield curve (when shorter-term bonds are paying more than longer-term bonds, which is usually a predictor of recession). The risk here, says Gargi Pal Chaudhuri, Managing Director and Head of iShares Investment Strategy Americas at BlackRock, is that if you hold too much too long, the risk of missing the rally goes up. In a rising interest rate scenario, she suggests one opportunity is to look at an ETF focused on high-quality medium-term bonds. On average, she writes in the iShares 2023 Midyear Outlook, “between 1990 and February 2023, core bond exposures performed 4% better than cash equivalents when the Fed held or dropped rates. Similarly, high quality short-term bonds performed 1.9% better than cash in the same environment.”* ETFs that provide this sort of allocation include iShares Core U.S. Aggregate Bond ETF (AGG) and iShares 1-3 Year Treasury Bond ETF (SHY). “There is a role for bonds in your portfolio,” says Chaudhuri. “I wouldn’t have said this a year ago when interest rates were 500 basis points lower.”
When A Recession Looks Likely
Often, the approach investors (professional and individual) will take during periods of extreme volatility is to search for safety, sector-by-sector. During a time when it looks like we’re headed toward a recession, for example, they may turn to sectors like consumer staples, utilities, or alcohol and tobacco, with the rationale that customers have to buy groceries, they have to keep the lights on, and they will (even during lean times) pick up a six-pack or their other favorite vice.
But with ETFs, rather than looking at sectors, investors can focus on the characteristics they’re looking for from these defensive stocks, Fan explains. These may be things like lower volatility, less leverage, or more stable earnings growth. This is called investing by “factor.” “Sectors are familiar to a lot of people, but looking at factors lends itself really well to different stages of a business cycle,” says Fan. With so much economic uncertainty ahead, staying invested may mean gravitating to the higher-quality end of the spectrum — like companies that worry less about leveraging or balance sheets. Possible investments like this could be the iShares MSCI USA Quality Factor ETF (QUAL), or the iShares MSCI USA Min Vol Factor ETF (USMV), which seeks to track an index comprised of U.S. stocks that have lower volatility characteristics than the market overall.
When We’re In A Bear Market
Although it seems like we’ve just come out of a bear market cycle, you know the next one is on the horizon — you just don’t know when. So, it pays to be ready with an investment strategy that you can put to work. Holding dividend-paying stocks is one remedy that has worked well in past bear markets. The iShares Core High Dividend ETF (HDV) seeks to track an index that screens for companies that have maintained above-average dividend payouts. Healthcare, consumer staples and utilities have also been bear market safety zones. And while you can target some of these companies with the “factor” strategy noted above, you can also buy ETFs that specialize in these particular portions of the market. “It’s not sectors or factors,” says Fan. “Its sectors and factors.”
Finally, it’s important to note that no matter what the economy is doing, your focus should turn to your personal economy. That means doing all you can to ensure you’re saving consistently (and grabbing all the possible matching dollars your employer has put on the table), rebalancing your portfolio when it gets out of whack (or picking an asset allocation ETF that does it for you), minimizing taxes and keeping investment costs as low as possible. Economic cycles come and go. But good habits like these should last forever.
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Note: This story was sponsored by BlackRock.
* Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance does not represent actual Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com.
Source: BlackRock, Bloomberg. Chart by iShares Investment Strategy. ‘Core bond exposures’ return as represented by Bloomberg US Aggregate Index, ‘cash equivalents’ as represented Bloomberg US Treasury Bill 1–3M, “high quality short-term bonds’ as represented by ICE BofA 1-5 Year U.S. Corporate Index. Returns rebased to 0 on the day of the last hike for each cycle. Cycles referenced include the final Federal Reserve hike in the past five hiking cycles: February 1, 1995, March 25, 1997, May 16, 2000, June 29, 2006, and December 19, 2018.
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.
There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses. The iShares Minimum Volatility Funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful. There is no guarantee that any fund will pay dividends.
Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and the general securities market.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the value of debt securities. Credit risk refers to the possibility that the debt issuer will not be able to make principal and interest payments.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.
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