This year has proved to be a challenging one for investors, with persistent economic and geopolitical risks testing market resilience. Unfortunately, the road ahead may remain bumpy, with investors likely to face further volatility in the months ahead.
Rising market expectations of an interest rate hike, rising concerns over a ballooning U.S. national debt and the ongoing tensions in the Middle East could keep uncertainty elevated and markets under pressure.
The CBOE Volatility Index, which reflects market expectations of near-term volatility, rose about 0.8% over the past trading session, taking the index up around 12% over the past five trading sessions. The rise in the volatility index highlights growing market uncertainty and suggests that investors are becoming increasingly cautious. This risk-off sentiment is also evident in the performance of the broader market.
The S&P 500 fell about 0.6% on Tuesday, declining 0.17% over the past five trading sessions and 0.80% over the past month. Meanwhile, the tech-heavy Nasdaq Composite was down 0.32% on Tuesday and has lost about 0.43% over the past month. The recent weakness underscores the pressure facing stocks as investors brace for continued market volatility.
Taking a Closer Look at Market Volatility
One of the biggest factors weighing on investor confidence is the ongoing geopolitical tension in the Middle East, particularly its impact on oil prices and the resulting inflationary pressure. The conflict between Washington and Tehran has entered its seventh month, with hardly any signs of tensions easing. Instead, the recent tit-for-tat strikes between both sides point to the possibility of a prolonged conflict, raising concerns and further complicating the market outlook for investors.
With Brent crude crossing the $100-per-barrel mark again, concerns over energy-driven inflation are gaining momentum. Rising oil prices could add to inflationary pressures, raising market expectations for further interest-rate hikes and also increasing the uncertainty around the Fed’s future policy path.
The prospect of higher interest rates could weigh on equities and further dampen investor sentiment. Meanwhile, political uncertainty could make an already complicated macroeconomic backdrop even more difficult for investors to navigate. The upcoming U.S. midterm elections could add another source of volatility, keeping investors cautious.
Additionally, with the national debt crossing the $40 trillion mark, rising debt levels continue to pose another challenge for investors. A growing debt burden can create economic headwinds, including the risk of elevated inflation, potentially adding to market uncertainty and weighing on investor sentiment.
How to Position Portfolios for Volatility and Long-Term Growth
Broader economic headwinds are likely to weigh on investor sentiment, encouraging a more cautious, risk-aware approach and prompting investors to reassess their portfolios. For those with allocations skewed toward higher-risk assets or limited diversification, gradually shifting toward a more balanced risk profile may be prudent.
As risk aversion rises, investors may increasingly favor stability and a long-term approach. Tilting toward defensive funds, combined with passive investing strategies with a long-term investment horizon, can help investors navigate potential near-term pullbacks while maintaining a focus on sustainable wealth creation. Such an approach can also help build more resilient portfolios over time.
These strategies can help investors create portfolio momentum and stay focused on long-term wealth creation rather than reacting to short-term market movements. By remaining invested instead of attempting to time the market or make tactical bets, investors can maintain a disciplined approach through periods of heightened volatility.
Defensive ETFs to Help Navigate Choppy Market Conditions
Against the current macroeconomic backdrop, investors may consider increasing exposure to defensive ETFs, with capital preservation and downside risk management as key objectives.
These funds can offer a dual advantage, helping cushion portfolios during periods of market stress while maintaining exposure to potential upside if conditions improve. A greater allocation to defensive assets can help strike a balance between risk and return, while providing added stability as investors navigate evolving economic and market conditions.
Ultimately, diversifying portfolios with defensive funds, while simultaneously keeping a long-term outlook, remains essential for navigating market uncertainty. Investors can adopt a balanced approach that prepares portfolios for a range of potential scenarios while maintaining exposure to longer-term growth opportunities.
However, shifting too heavily toward defensive assets could make a portfolio overly conservative. While a greater allocation may help manage downside risks, it could also limit participation in potential market gains. A measured allocation to defensive funds can help investors position ahead of uncertainty without becoming overly cautious.
Proactive positioning can be more effective than reacting after losses materialize, allowing investors to manage downside risks more effectively rather than playing catch-up when markets turn volatile.
Quality ETFs
Amid market uncertainty, quality investing emerges as a strategic response, providing a buffer against potential headwinds. This approach prioritizes identifying firms with robust fundamentals, consistent earnings and lasting competitive strengths. Investing in such high-quality companies can mitigate volatility for investors.
Investors can look at funds like iShares MSCI USA Quality Factor ETF QUAL, Invesco S&P 500 Quality ETF SPHQ and JPMorgan U.S. Quality Factor ETF JQUA.
With an asset base of $47.73 billion, QUAL is the largest fund among the group. SPHQ is the most liquid fund, with a one-month average trading volume of 1.41 million shares. Meanwhile, JQUA stands out as the cheapest option, charging an annual fee of 0.12%.
Utility ETFs
As a low-beta sector, utilities are relatively shielded from market volatility, making them a defensive investment and a safe haven during economic turmoil. Investors often turn to utilities during downturns due to the steady demand for these companies' services.
Investors should gain from funds like Utilities Select Sector SPDR Fund XLU, Vanguard Utilities ETF VPU and iShares U.S. Utilities ETF IDU.
XLU and VPU have a Zacks ETF Rank #2 (Buy), with XLU being the cheapest option, charging an annual fee of 0.08%. XLU and VPU offer similar dividend yields of 2.78% and 2.77%, respectively.
Consumer Staple ETFs
Increasing exposure to consumer staple funds can bring balance and stability to investors’ portfolios. Consumer staples include everyday necessities that typically see steady demand across economic cycles, making the sector less sensitive to economic fluctuations.
Consumer staples stocks are often favored for their defensive characteristics, steady growth potential and relatively low volatility, particularly during economic downturns. At the same time, the sector can participate in broader market recoveries, offering a combination of stability and growth that makes it a valuable component of a diversified portfolio.
Investors can consider State Street Consumer Staples Select Sector SPDR ETF XLP, Vanguard Consumer Staples ETF VDC and Invesco S&P 500 Equal Weight Consumer Staples ETF RSPS.
Among the abovementioned funds, XLP stands out as a well-rounded option. The fund is the cheapest option, charging an annual fee of 0.085%, while also offering the highest dividend yield of 2.60%.
XLP is also the largest and most liquid fund, with an asset base of $14.68 billion and a one-month average trading volume of about 8.83 million shares.
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State Street Consumer Staples Select Sector SPDR ETF (XLP): ETF Research Reports
State Street Utilities Select Sector SPDR ETF (XLU): ETF Research Reports
Vanguard Utilities Index Fund ETF Shares (VPU): ETF Research Reports
iShares MSCI USA Quality Factor ETF (QUAL): ETF Research Reports
Invesco S&P 500 Quality ETF (SPHQ): ETF Research Reports
Vanguard Consumer Staples Index Fund ETF Shares (VDC): ETF Research Reports
iShares U.S. Utilities ETF (IDU): ETF Research Reports
JPMorgan U.S. Quality Factor ETF (JQUA): ETF Research Reports
Invesco S&P 500 Equal Weight Consumer Staples ETF (RSPS): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).