A Sea Of Red: ETF Trades You Must Know #3

January 19, 2022

A Sea Of Red: ETF Trades You Must Know #3

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The effects of higher rates continue to sweep through the markets, shaking up existing trends and relationships. Which ETFs are doing well, and which aren’t?

A Sea Of Red

US small caps look poised to break out to the down side, which would herald more selling
- If this happens and the IWM keeps falling, it would be a very bearish signal for the rest of the markets
- Look to other markets for confirmation: stronger USD and flattening US Yield Curve

Sector performance continues to diverge
- Financials (XLF), Energy (XLE), and Consumer Staples (XLP) remain very bullish
- Consumer Discretionary (XLY), Real Estate (XLRE), and Utilities (XLU) are starting to look weak, although still trading in broader up trends
- XLY’s weakness is the wildcard here, especially in relation to XLP’s strength – we are heading into a rate hiking cycle with consumer staples stocks outperforming consumer discretionary stocks; how strong can the economy really be?

Fixed income ETFs are poised for more carnage
- Corporate bond ETFs LQD and HYG are testing key support levels
- Emerging Markets sovereign bonds (EMB), already in a bearish channel, have broken out to the down side

Trading Ideas

Long:
- XLE to take advantage of how bullish oil prices are
- XLF if you buy into the narrative that rate hikes are good for bank stocks
  - If you don’t, most traders do, and would be looking to position themselves accordingly
  - Regardless, XLF is trading in a very bullish manner
- XLI is starting to look like a decent bet
  - Is currently more defensive than XLU, especially with traders following the “higher rates = utilities less attractive” narrative
  - Retains upside potential from stronger economic growth
- XLP is an interesting bet which could offer the best of both worlds
  - Defensiveness against current sell off and market volatility
  - Upside potential from very bullish trend

Short:
- IWM on a break below its range
  - Or buy IWM puts if you want to take advantage of a possible spike in volatility
- LQD, HYG, EMB, TLT
  - The entire fixed income ETF space looks like it’s headed lower as rates (and their expectations) keep rising
  - EMB looks the weakest technically
- XLY is struggling, and if IWM does break to the downside, it’s hard to imagine XLY doing well
  - Could hedge a XLY short with a XLP long to create a pair trade that still makes money if XLY falls, and loses less if XLY changes direction