2 ETFs To Consider Buying (And 1 To Avoid) This Week

With the markets writing off short-term inflation risk as transitory, the long case for gold may have disappeared.
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You'll notice a definite thematic twist to this week's ETF picks. Whereas last week's list focused more on specific sectors impacted by the short-term recovery conditions, including banks and infrastructure plays, this week I'm going to take a closer look at ETFs that should react to current short-term economic conditions.

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The overall market narrative hasn't changed to any significant degree over the last month. We know that the post-COVID recovery continues to make progress, although there are still pockets of weakness. The labor market is struggling to pick up some of its slack as workers remain on the sideline, while wage growth beyond the leisure & entertainment sector still hasn't picked up. Don't be surprised if we see GDP growth estimates for the rest of 2021 get revised downward at some point.

The pair of ETFs on this week's buy list focus on themes that have performed well lately and could continue to do well if the economy continues to grow, but still needs some Fed assistance to get there.

Here are three ETFs I'm going to be watching this week and the narratives that go along with them.

Invesco S&P 500 Quality ETF (SPHQ)

Quality stocks tend to perform well in periods uncertainty. We saw in parts of the late 2018 mini-bear market and again during the COVID bear market. Outside of that, quality stocks have mostly lagged over the past several years as investors focused almost exclusively on growth.

The quality factor, however, has made a strong comeback over the past two months and has become the market's best-performing factor over the past 1- and 3-month periods.

SPHQ vs. SPY

SPHQ vs. SPY

The curious thing about quality's recent run, however, is that it's coming during a time when the S&P 500 is still hitting all-time lows, not when stocks are correcting. When you look at the chart above and also consider that U.S. Treasuries have performed well over the same time frame, it's easy to make the argument that investors are positioning themselves more defensively.

I'm expecting that the market might not be quite so bullish over the 2nd half of the year. Cyclicals haven't performed as consistently well as you might expect during a more robust recovery. Commodities prices are coming back down to earth. Inflation may or may not be a problem. The Fed at some point is going to need to tighten policy and let the economy survive on its own. All of these are potential risk factors that support the idea of overweighting more cash-rich mature companies in your portfolio.

Vanguard Growth ETF (VUG)

The one consistent theme that we've seen over the past month has been the leadership of growth stocks. The three primary growth sectors - technology, consumer discretionary and communication services - have all been beating the S&P 500 handily over the past month after mostly trending towards underperformance during the 4th quarter of 2020.

VUG vs. SPY

VUG vs. SPY

This is what we've come to see out of growth stocks, and tech in particular, throughout this recovery. When we've more genuine signs of recovery from the economy, cyclicals have tended to take the lead. But when the recovery looks like it's got some question markets and the Fed continues to step in with dovish commentary, it's growth that takes the lead.

The labor market is still showing signs of weakness and that may not abate until the end of the 3rd quarter of this year, when expanded unemployment benefits are scheduled to expire. Market conditions look like they'll favor growth stocks throughout the remainder of summer, especially as we approach the 2nd quarter earnings season.

SPDR Gold Shares ETF (GLD)

A lot of investors were waiting for the huge spike in gold prices as inflation rates were expected to soar coming out of the COVID recession. The inflation has come. The spike in gold prices has not.

Gold Price

Gold Price

Part of the reason is that the Fed has been driving this "transitory" narrative throughout the recovery. Yes, the low base effect is probably skewing the number higher a bit right now, but there's no question looking at the month-over-month increases (or just paying to what's going on out in the real world with food and gasoline prices) that inflation is here. Even as the CPI and PCE numbers come in, investors seem to have chosen to buy into the what the Fed is saying and believe that the current spike in consumer prices will fade either later this year or into 2022.

That means investors have also been backing off of inflation hedges, such as gold. If you look at history, gold has really only soared in value when inflation has been above 5% for a longer period of time. The inflation rate is there today, but if there's a general consensus that it won't be there for long, the chances for a meaningful rise in gold prices here is probably minimal.

This will be one to keep an eye on, however, because if the expectation of short-term inflationary pressures turn into longer-term concern, gold could become a buy once again.

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