10% Correction in the Cards? Play ETFs With Inherent Strength

Christel Deskins

Stock markets have been in good shape in recent months despite the rise in COVID-19 cases and lackluster economic scenario. But many investors fear that the rally doesn’t have legs. “Sometimes the market rallies and it makes perfect sense. Then there are days like today, when I can’t take how […]

Stock markets have been in good shape in recent months despite the rise in COVID-19 cases and lackluster economic scenario. But many investors fear that the rally doesn’t have legs. “Sometimes the market rallies and it makes perfect sense. Then there are days like today, when I can’t take how stupidly bullish this market can be,” said CNBC Mad Money host Jim Cramer, as quoted on MarketWatch.

Michael Wilson, chief U.S. equity strategist at Morgan Stanley, and his colleagues believe that “the most likely outcome remains a 10% correction in the broader index led by the beneficiaries before the recovery and bull market continues.”

Presidential election uncertainty, massive pandemic stimulus and again embittering U.S.-China relation may worsen the market momentum. The winning index of the pandemic — the Nasdaq and the winning sector technology — may see overvaluation concerns.

“Once the correction is complete we expect the bull market to continue to broaden out and based on what we think will continue to be a surprising recovery in the economy and earnings later this year and into 2021,” the Morgan Stanley analysts wrote, quoted on MarketWatch.

Is the Scenario That Scary?

The scenario may not be that scary as many companies have come up with upbeat earnings this season and one should bet on fundamentals before picking stocks and ETFs. The earnings estimate revision trend continues to improve, with estimates for the current period (2020 Q3) and beyond steadily going up, marking a key shift in the post-pandemic earnings picture.

Several economic datapoints came in upbeat in recent months, pointing at pent-up consumer demand. Vaccine and treatment hopes may also push markets upward. Below we highlight a few such options that could win ahead.

WisdomTree U.S. Quality Dividend Growth ETF (DGRW)

The underlying WisdomTree U.S. Quality Dividend Growth Index is a fundamentally weighted index that consists of dividend-paying stocks with growth characteristics. The fund deals with two important factors in a company — dividend and growth — both are desirable in a record-low yield environment. The fund yields 2.20% annually.

Technology Select Sector SPDR Fund (XLK)

This is a broader technology fund and houses many well-known tech stocks. As far as valuation is concerned, the fund is not extremely overvalued with a P/E of 26.79X, which way lower than the most valued fundGlobal X Cloud Computing ETF (CLOU) (P/E of 82.28X).

For the Technology sector, about 84.6% of the sector’s market capitalization in the S&P 500 Index reported Q2 results. Total earnings for these tech companies are down -1.7% on +2.5% higher revenues, with 89.6% beating EPS estimates and 79.2% beating revenue estimates. This is a bigger beat percentage than we saw from the same group in the preceding quarter, per Earnings Trends.

SPDR SP Health Care Services ETF (XHS)

The broader medical sector is pretty well placed amid the pandemic, for a valid reason. The sector has seen earnings growth of 1.9% in Q2 and is expected to log an earnings decline of 3.1% in Q3, per Earnings Trends issued on Aug 5, 2020. The sector recorded revenue growth of 3.4% in Q2 and is likely to log 8.3% revenue growth in Q3. The fund gained 12.3% in the past month.

VanEck Vectors Gold Miners ETF (GDX)

Precious metals like gold and silver have been rallying hard lately. This is because investors’ drive for safe-haven investments have emanated from rising virus cases, collapse in real bond yields, fear of prolonged global recession and ongoing uncertainty surrounding the U.S.-China relation.

The metal rally is here to stay as evident from the recent price target raised by BofA Securities. Analyst Michael Jalonen from BofA Securities raised the average 2021 real gold price forecast from $2,012 to $2,159. The firm also upped its 2021 real silver average price forecast from $21.95 to $30.49 and its 2021 real copper average price forecast from $2.77 to $3.10, as quoted on Benzinga. This should work wonders for mining ETFs like GDX.

SPDR SP Retail ETF (XRT)

The Zacks Rank #2 (Buy) fund is heavy on Internet & Direct Marketing Retail with about 26% exposure. The focus should make the fund a winner in the coming days given the rise on online retailing. The earnings picture has also been moderate for the retail sector with 18.6% decline in Q2. The sector is likely to log 12% fall in earnings in Q3, which is decent given the lackluster conditions of many other sectors.

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