Nibbling At Risk With ETFs In The Week Ahead

Post-Labor Day trading brought solid showings by the major U.S. indexes as stocks posted decent gains during a holiday-shortened week, but September's reputation for being a volatile month for equities could be on full display this week as one of the most widely anticipated Federal Reserve meetings in recent memory takes place.

This much is clear: Traders' bets on the Fed raising rates are dwindling though 10-year Treasury yields have climbed about 2.5 percent over the past month. Further confirmation of traders' reduced expectations of a September rate hike come by way of this month's exchange traded fund inflows.

Five of this month's top 10 asset-gathering ETFs are fixed income funds and four of those five ETFs are Treasury funds. That quartet includes the SPDR Barclays 1-3 Month T-Bill ETF BIL, the somewhat rate-sensitive iShares 7-10 Year Treasury Bond ETF IEF and the ultra-rate sensitive iShares 20+ Year Treasury Bond ETF TLT. Translation: Bond ETFs will points of focus in the week ahead with longer duration fare, such as TLT, possessing the potential to rally if the Fed does not boost rates. 

Sticking with the theme of interest rates, for lack of a crystal ball, we cannot guarantee what the Fed will or won't do this week. However, it is a guarantee that preparation is a good idea. So it would be a good idea for equity investors to keep close watch on the sector ETFs that have a tendency to perform well immediately following hawkish Fed action. 

That includes cyclical sector funds, such as Energy Select Sector SPDR XLE and the Technology Select Sector SPDR XLK. As we highlighted last Friday, Bank of America Merrill Lynch pointed out that “Energy did the best one to 12 months into a Fed tightening cycle and was ranked one or two during the 12 months after Fed liftoff, based on average cumulative price returns over these periods.”

XLE is the worst performer among the nine sector SPDRs this year, but the second-best asset gatherer behind only its health care counterpart. However, be careful of energy ETFs in the near-term as nine of the 10 worst-performing ETFs over the past week were energy funds.

In the category of investors nibbling at risk, the iShares Russell 2000 ETF IWM, the largest small-cap ETF hauled in more than $1 billion in new assets last week. An interesting anecdote about the Russell 2000 against the S&P 500: The small-cap index has recently been less volatile than the S&P 500, a rarity as Bloomberg reports.

“Since stocks started selling off last month, implied volatility, the options-derived measure of turbulence codified in the VIX, has repeatedly risen above a similar measure tied to the Russell 2000 Index of smaller stocks. It’s closed that way six times since Aug. 24, compared with twice in the prior 11 years,” according to Bloomberg.

For investors with international inclinations, in the wake of Standard & Poor's downgrade of Brazil's sovereign credit rating to junk status, markets, as they do, are wondering what country could be next. There are ETFs for that. Keep an eye on the tenuous grasps on investment-grade ratings by the nations tracked by the Market Vectors Russia ETF RSX and the iShares MSCI Turkey ETF TUR, among others.