This is where ETF investors could hide if the US Treasury sell-off turns US stocks upside down

By Isabel Wang

Hello! This is MarketWatch reporter Isabel Wang bringing you this week’s ETF Wrap. In this week’s edition, we look at how ETF investors can navigate turbulent financial markets following a sell-off in U.S. Treasury bonds that pushed long-term borrowing costs to their highest in more than a decade and undercut stock prices. remain tense.

Please send tips or feedback to [email protected] or [email protected]. You can also follow me on Twitter at @Isabelxwang and find Christine at @CIdzelis.

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A renewed slide in U.S. Treasury markets, which has pushed the 10-year Treasury yield to a 16-year high as a new era of longer-term higher interest rates takes hold, is forcing ETF investors to move toward an exit have focused on a large selection of exchange-traded funds over the past week, most notably the iShares 20+ Year Treasury Bond ETF TLT.

TLT, one of the most popular bond ETFs that tracks a market-weighted index of U.S. Treasury securities with maturities of 20 years or more, posted its lowest closing price earlier this week since the early days of the 2007-2009 financial crisis. The yield on the 10-year Treasury note BX:TMUBMUSD10Y fell 2 basis points to 4.715% on Thursday after reaching 4.801% on Tuesday, its highest close since August 8, 2007, according to Dow Jones Market Data.

See: Bond investors feel the heat as popular bond ETF posts lowest close since 2007

The bond market, particularly the U.S. Treasury bond market, has historically been less volatile and has often performed better than other financial assets during economic downturns. However, that doesn’t mean that bonds aren’t without their own risks.

Rising yields reflect a falling price for the securities as interest rates rise, hitting existing Treasury bondholders.

See: Rising government bond yields are unsettling financial markets. Here’s why.

The surprising strength of the U.S. economy, as reflected in this week’s jobs data, coupled with hawkish statements from Federal Reserve officials that suggest the central bank may need to further tighten monetary policy, have led to the sell-off this week bonds.

Meanwhile, a positive Treasury term premium, or the compensation that investors demand for the risk of holding a Treasury bond to maturity, has also contributed to a sharp selloff, as a rising U.S. budget deficit and the Treasury Department’s need to issue more debt , the Treasury has pushed prices to 16-year lows.

According to FactSet data, TLT TLT has fallen over 50% since its peak in August 2020. The losses correspond “pretty closely” to losses in the stock market from peak to trough during the global financial crisis, said Tim Urbanowicz, head of research and investment strategy at Innovator ETFs.

“It’s not insignificant…It really makes you think about how you manage risk, because the part of the portfolio that’s supposed to act as a risk mitigator can’t fall as much as we’ve never seen in stocks. “-Market decline. This is a big problem,” Urbanowicz told MarketWatch.

For this reason, ETF investors have very few options when evolving or adjusting their asset allocation in the longer-term higher interest rate environment, but for safety reasons, there are still some shock-proof assets, according to ETF strategists.

Ultra-short-term bond funds

ETF investors who still prefer bonds may consider hiding in ultra-short-term bond funds to avoid duration risk, as the Fed may still need to raise interest rates to curb inflation by the end of 2023, said Neena Mishra, head of ETF research at Zacks Investment Research.

The SPDR Bloomberg 1-3 Month T-Bill ETF BIL, which tracks all publicly issued US government bonds with a remaining maturity of less than 3 months and at least 1 month, offers a yield of 5.43%. The fund saw over $1 billion in inflows in the week ending Wednesday, according to FactSet data. This is the largest inflow among the 800-plus ETFs MarketWatch tracked last week.

Meanwhile, Mishra said investors who want active management with “better navigation to markets” can consider JPMorgan Ultra-Short Income ETF JPST, an actively managed fund that invests in a variety of debt, including corporate bonds, Asset-backed securities, and mortgage-related debt, and U.S. government and agency debt. JPST saw $15 million in inflows last week and returned 5.76%, according to FactSet data.

Flows into longer-dated bonds and utilities

Although the bond crisis hit the popular TLT fund hard as the 10-year Treasury yield soared, some retail traders have already started buying the fund’s historic decline, which focuses on longer-dated Treasury bonds, a team of data analysts said from Vanda Research led by Marco Iachini, Senior Vice President.

According to FactSet data, TLT saw inflows totaling $686 million in the week ending Wednesday, ranking it 8th among over 800 ETFs tracked by MarketWatch over the past week.

Along with the strong “dip buying” in TLT, retailers have also poured an “unprecedented amount” of capital into the utilities sector, Iachini and his team said in a note Thursday. The Utilities Select Sector SPDR Fund XLU saw $141 million in inflows last week, according to FactSet data.

“While purchases of utility stocks are typically significantly smaller than purchases of technology stocks, last week’s inflows are far greater than any previous five-day period, exceeding inflows into the sector at the start of the coronavirus crisis “The downside to this dynamic is that institutional investors have likely reduced their exposure to utilities during this bond sell-off episode, making the sector a potentially more attractive stock bet should interest rates move higher approaching local highs.”

See: Utilities stocks ‘decimated’ by rising interest rates fall into unusual trading territory, custom chart shows

Small caps are cheap “for a reason,” so don’t buy them too early

Many small-cap stocks have been trading at a significant discount to their larger-company counterparts, providing an attractive entry point for some investors who believe the forward price-to-earnings ratio for small-cap stocks is low enough to trade on offer potential for outperformance in the longer term.

However, IWM small-cap stocks are inherently more sensitive to higher interest rates than many of the large-cap stocks, which have the ability to be “flexible” and generate strong cash flow, Urbanowicz said.

“Right now it’s really important to not just rely on a specific sector, but to really have integrated risk management at the index level to take a lot of the guesswork out of the equation,” he added.

See: Small-cap ETFs may look attractive as recession worries ease, but blindly chasing the rally isn’t without risk

ETFs with defined results

That’s why Urbanowicz and his team at Innovator ETFs believe the increasingly popular outcome-focused ETFs, or “buffer” funds, could limit downside risk and help investors navigate a turbulent interest rate environment.

See: An ETF that can’t fall? This new “buffer” fund is intended to offer 100 percent protection against stock market losses

For example, the Innovator Equity Defined Protection ETF TJUL, the “first fund of its kind,” aims to provide investors with the upside return of the SPDR S&P 500 ETF Trust SPY up to a cap of 16.62%, as well as a full buffer against its downside above a results period of two years.

Meanwhile, the Innovator Defined Wealth Shield ETF BALT offers a 20% downside buffer on the SPY every three months, which represents a “very shortened outcome period” and does not require the stock market to actually rise for the strategy to gain value, Urbanowicz said.

“An important reason [to consider this strategy] Does it offer investors the opportunity not only to maintain their equity exposure, but also to hide because they do [funds] “We have a known level of risk management,” he added.

As usual, here’s a look at the best- and worst-performing ETFs from the last week through Wednesday, according to FactSet data.

The good…

Top Performers %Performance YieldMax TSLA Option Income Strategy ETF 6.2 United States Natural Gas Fund LP 2.0 Quadratic Interest Rate Volatility & Inflation Hedge ETF 1.6 Technology Select Sector SPDR Fund 0.9 ProShares Bitcoin Strategy ETF 0.9 Source : FactSet data through Wednesday, October 4th. Start date September 28th. ETNs and leveraged products are excluded. Includes $500 million or more of ETFs traded on the NYSE, Nasdaq and Cboe.

…and the bad

Bottom performers %Performance AdvisorShares Pure US Cannabis ETF -11.3 Sprott Uranium Miners ETF -10.6 Global X Uranium ETF -10.2 VanEck Oil Services ETF -9.2 SPDR S&P Oil & Gas Exploration & Production ETF -9.1 Source : FactSet data

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