Looking toward 2018, ETF investors should be re-evaluating their investment portfolios and plan for the year ahead.
On the recent webcast (available on demand for CE Credit), ETF Top Trends and Insights for 2018, Salvatore Bruno, Chief Investment Officer and Managing Director for IndexIQ, outlined a year that has so far exceeded many observers’ expectations. Bruno pointed out that the economy has been steadily improving, with unemployment rates lower, personal consumption and expenditures rising, household debt down, consumer confidence higher, ISM manufacturing PMI strengthening, industrial production increasing and U.S. GDP expanding.
Nevertheless, Bruno warned of more muted growth ahead as the economy extends its expansionary direction. The U.S. economy expanded 3.0% in the third quarter of 2017, but the mean forecast calls for a 2.1% growth in the fourth quarter of 2018. Furthermore, investors may also see market growth slow down as S&P 500 price-to-earnings ratios have steadily risen toward historic highs, with energy and information technology sales and earnings growth leading the charge.
Meanwhile, the fixed-income market has surprised observers as yields on government debt remain depressed and spreads on short- and long-term Treasury bonds tighten. Bruno also pointed out that tighter spreads in the bond market may reflect a growing economy, rising profits and higher commodity prices.
Given the ongoing depressed yields after the multi-year bull run in the bond market, fixed-income investors may be exposed to greater risks, especially if they are tracking traditional benchmark fixed-income indices.
“The composition of the Barclays Aggregate Index has changed, significantly altering its risk/reward profile,” Kelly Ye, Director and Fixed Income Research Analyst for New York Life Investments, said. “Today, investors are over-exposed to interest rate risk in the form of duration while being compensated with a lower yield.”
Consequently, Ye argued that investors may consider looking toward higher quality, high-yield debt as a way to improve returns while diminishing risk.
For instance, investors may consider alternative fixed income ETF offerings from IndexIQ, including three first-of-their-kind factor-based fixed income offerings: the IQ Enhanced Core Bond U.S. ETF (NYSE Arca: AGGE) and IQ Enhanced Core Plus Bond U.S. ETF (NYSE Arca: AGGP), which were launched in May of 2016, and the IQ S&P High Yield Low Volatility Bond ETF (HYLV), the first high yield low volatility fixed income ETF, which launched in February of 2017.
The ETF industry has also capitalized on the ongoing bullish environment. ETF asset inflows are enjoying another record year, with year-to-date inflows already outpacing the overall assets gained for the whole of 2016. Smart beta has also attracted its fair share of interest, notably smart beta income ETFs, which nearly saw assets doubled in 2017.
While the commodities space has been among the weaker segments of the markets, Bruno argued that there are opportunities in the current commodities cycle, especially since commodities typically follow a well-worn boom and bust cycle. Investors interested in the global natural resources space can take a look at broad ETF options, such as the IQ Global Resources ETF (NYSEArca: GRES).
Looking ahead, the markets may be moving toward a boom cycle after producers slashed capital expenditures in response to falling prices in 2014 and 2015, which may limit supply and bolster pricing. The capacity cuts have primed the markets for potential supply and demand imbalances. Meanwhile, global economies continue to strengthen and would renew demand for raw materials.
Bruno also argued that commodity producers may be another opportunity as many trade at lower multiples to the market than historical averages, adding that “being long equity commodity producers may be a good way of implementing this theme into an investment portfolio.”
Delving into the current market conditions, Mark Lacuesta, Director of Index Strategies for IndexIQ, outlined the potential implications of the Trump tax reforms on the markets. The reduction of the top corporate tax rate from 35% to proposed 20% by both chambers of Congress will cut the overall tax burden of U.S. companies.
“As currently written, we believe investors in U.S. equities may benefit from the effects of proposed changes to corporate taxes,” Lacuesta said.
Additionally, the adoption of a territorial tax system and the reduction of the Cash Repatriation rate from the currently high 35% will entice off-shore cash to return to the U.S. Lacuesta argued that the repatriation cash holiday would be particularly beneficial toward large-cap companies, pointing out 76% of large-cap companies derive a portion of their revenues outside of the United States compared to only 57% of small-caps.
The tax reforms could translate to greater value for shareholders. The additional cash could fund share buy-backs or special dividend payout to shareholders. In addition, the cash can be used toward corporate expansion or capital expenditure investment to increase working capital or invest in equipment to expand capacity or productivity.
Lacuesta warned that the tax reform could lead to additional rate hikes. Nevertheless, small-caps could stand to benefit in this type of environment.
“We believe small caps are geared toward growth and will benefit in a rising economy,” Lacuesta said. “Small cap stocks have historically outperformed during rising rates.”
ETF investors seeking a way to target the growth potential of small-caps and a smart beta strategy to diversify risks may look to the IQ Chaikin U.S. Small Cap ETF (NasdaqGM: CSML), which tries to reflect the performance of the Nasdaq Chaikin Power US Small Cap Index. The underlying index incorporates the so-called Chaikin Power Gauge that combines four primary factors, including value, growth, technical and sentiment.
Financial advisors who are interested in learning more about trends and insights to look for in 2018 can watch the webcast here on demand.