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

The consumer discretionary sector looks interesting, junk bonds don't and the first ever bitcoin ETF in the United States!

After a September that saw the stock market get spooked by concerns over the Congressional debt ceiling showdown, inflation risks and rising interest rates, both equities and Treasuries look like they're getting back on track. The debt ceiling can was kicked down the road until December. Interest rates look like they might be settling into a range instead of climbing higher. Inflation is looking less transitory by the day, but it appears that investors are at least getting comfortable with the potential impacts it might present.

Last week offered a couple of reasons why this bullish run in equities could have some legs. Market watchers were nervous about how the labor market, supply chain concerns and rising input costs would impact Q3 earnings. Initial results, at least from the big banks, suggest those worries might not be as impactful as feared. Granted, banks aren't really that affected by things like supply chains and input costs in the way that cyclicals would be, but earnings and revenues were strong and forward guidance even looked encouraging. Loan growth is still on the weak side and financials are being forced to look to alternate revenue streams in order to fill in the gaps, but the results look encouraging so far. We'll get a better idea of how the rest of the economy is faring this week.

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But then we got the September retail sales report on Friday, which posted an unexpected 0.7% rise compared to an estimated -0.2% figure. The forecast was based largely on the expectation that rising inflation in food, energy, rent, housing and medical care would eat into consumers' ability or desire to spend. It turns out that the consumer is more optimistic than anticipated. That could interpreted one of two ways. First, it could be another piece of evidence that, despite some short-term bumps in the road, the economic recovery is still making progress and we could see growth continue to carry through into the new year. Second, it could mean that inflation, which is already above 5% overall, has the catalyst to move even higher. We're seeing some of the base effects of the COVID recession starting to roll off, so the longer the inflation rate remains in that 4-5% range runs the risk of it being non-transitory and harmful to the economy.

That makes Treasury rates important to watch here. The 10-year yield had been settling back down following a multi-month stretch that pushed it above the 1.6% level, its highest reading since June. However, the yield has risen 10 basis points over the past couple of trading days and is at risk of breaching the 1.6% mark once again.

If we're playing the cyclical recovery narrative here (and cyclicals have performed very well in recent weeks), I also want to see small-caps outperforming here. That hasn't really happened with any degree of strength so far, so I think we have to acknowledge that we're still at risk of a minor pullback here. Given what we're seeing in sales and earnings, though, it's sure looking like equities want to move higher here. With the debt ceiling probably not becoming an issue for another month or so, I'm not sure I'm seeing a short-term catalyst to derail things for a little while.

With that being said, here are three ETFs I'm going to be watching this week and the narratives that go along with them.

Invesco S&P SmallCap Consumer Discretionary ETF (PSCD)

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If you believe that the cyclical recovery remains intact and last week's sales data confirms that the consumer is still in good shape, small-cap discretionary stocks seem like a logical landing spot. The 35% year-to-date return for PSCD is a bit deceptive because all of those returns came in the months of January and February. Since the beginning of March, this fund has pretty much moved sideways.

Small-cap discretionary has underperformed large-cap discretionary pretty steadily since the beginning of June. Since that time, the Consumer Discretionary Select Sector SPDR ETF (XLY) is up 10% compared to a 7% loss for PSCD. If investors are interested in pushing the cyclical recovery trade higher, there's a lot of ground to be made up in small-cap discretionary. Higher inflation rates could be particularly damaging to this group, so watch out if Treasury yields move up here. There's a bullish narrative, however, that could be likely to play out over the next month or so.

ProShares Bitcoin Strategy ETF (BITO)

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So this is going to be a first. I've never talked in this space about a fund that hasn't even officially launched yet, but it's going to be the unquestioned #1 topic of conversation this week. The first bitcoin ETF, BITO, is about to launch and could possibly be followed with another bitcoin ETF launch later this week, possibly the Invesco Bitcoin Strategy ETF, but we'll save that for another day.

The most important factor to understand about BITO is that it is not an actual bitcoin ETF, per se. It will invest in bitcoin futures contracts, not physical bitcoin itself. In that way, it's like a lot of the commodity ETFs that you already see out there, most popularly oil ETFs. Bitcoin futures contracts give you good, but not great, crypto exposure and they're about the best option fund investors have at the moment if they want to get in this space without needing to open up an account with a place like Coinbase and buying bitcoin directly.

The SEC was willing to approve a bitcoin futures ETF because, well, futures contracts are regulated and that gives the regulatory body some degree of comfort with their structure and safety, especially since we have precedents to work with. It's worth noting that Canadian bitcoin ETFs have been trading for some time already without issues, so there's probably little risk of anything going seriously wrong with BITO or any subsequent bitcoin ETFs to come.

A physical bitcoin ETF would be better since it would provide tighter correlation to actual bitcoin prices and wouldn't need to worry about the damaging effects of roll costs. Again, this could be described as a "good, not great" option for crypto exposure in an ETF, but until we get to the point where the SEC is willing to green light an ETF that holds actual bitcoin, it's about the best option there is. And, yes, I consider it a better choice than the Grayscale Bitcoin Trust (GBTC).

KraneShares Asia Pacific High Yield Bond ETF (KHYB)

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The chart of this fund says it all. This is a portfolio of mostly Chinese junk bonds and it's been severely impacted by, at first, the Evergrande default and, second, subsequent interest payment defaults by its peers in the Chinese real estate space. While the impact of Evergrande has mostly been contained to the Asian continent, it's clearly a more widespread problem than many had initially thought.

Unless you're an investor who likes trying to catch falling knives (I am not one of them), this sector is probably best avoided at all costs. I think it's probably likely that this group, and Chinese equities in general, have further to fall before all is said and done. KHYB's site currently quotes a yield of more than 10%. Don't be tempted by it. That's entirely a product of the falling share price and we quite likely to see income distribution reductions over the next couple of months.

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