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

Conditions are looking more bullish in the near-term, but now's not the time to be reaching for high yield.

Except for one day last week, stocks largely took China's Evergrande default in stride. The government funding expiration that's set to expire at the end of the week, and would result in a government shutdown if not addressed, is looking like it will come to a peaceful resolution. The only major political event yet to be resolved is the debt ceiling. We know that Congress can't possibly let the government default on its debt. It's simply way too risky, both politically and economically, for it to happen. The only thing we don't know is the path we will take to get to a resolution. Will it require concessions on either side? Will it come down to the absolute last minute like in 2011? Will the ratings agencies or the markets decide that U.S. government should have the "highest" quality rating?

This, I think, is the biggest tail risk that the market faces today.

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In terms of fundamentals, the equity markets look like they're in relatively good shape. Both large-caps and small-caps enjoyed a nice rally back into the green following Monday's slide. The VIX is back in the 17-18 range, which is where you want it to be if you're looking for further gains here. Gold is looking weaker. Treasuries are looking much weaker. The dollar is strengthening and could continue to strengthen if government bond yields keep moving higher. Falling Treasury yields were the one thing that were preventing me from getting fully on board with the idea that equities were ready to make the next leg up, but the Fed seems to have convinced investors that the long-term recovery is still intact and the central bank's plan to pull back support later this year is a sign of strength and not reason to panic.

The early trading on Monday suggests that investors are still in a bullish mood. As I write this, the S&P 500 is flat, but the Russell 2000 is up about 1%. Treasuries are down again as the 10-year yield briefly pushed above the 1.51% mark. Keep in mind that this hit its intermediate-term low of 1.12% as recently as August, so there's definitely a sense of risk-on and economic strength happening here.

The short-term (and by that I mean the next week or two) are feeling bullish, but be prepared to turn cautious as the debt ceiling debate comes to a head around the middle of October.

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 KBW Bank ETF (KBWB)

source: ETF Action

source: ETF Action

Of all the things that we saw in the financial markets last week, the biggest, in my opinion, was the spike in Treasury yields. The 10-year yield moved all the way up to 1.5%, its highest level since all the way back in July. This could be really interesting if it sticks.

Over the past six months, Treasury yields had generally trended lower even as stock prices pushed higher. With the economic recovery slowing and the Fed looking to begin pulling back on its support of the markets, fixed income investors were still positioning themselves defensively throughout.

But the central bank's plan to begin tapering later this year has mostly been met with positivity by investors. They seem to be taking it as if even though there will be some short-term bumps along the way, the Fed is confirming that the long-term recovery and eventual expansion are still in place. The reaction by the Treasury market is consistent with a strengthening economy.

If that's the case, conditions just got more bullish for banks. They benefit from higher rates as the improve margins and profitability. Cyclicals have been mostly a mixed bag over the past several weeks, but KBWB has outperformed the S&P 500 (SPY) by 5-6% over the past few weeks. If rates continue to move higher and the Fed sticks with its plan, there's plenty of room for bank stocks to keep moving higher.

ARK Fintech Innovation ETF (ARKF)

source: ETF Action

source: ETF Action

I know the ARK ETFs haven't been a particularly popular topic for many investors this year, but there's little doubt that these ETFs can fly when their disruptive innovation theme is in favor. The markets are still favoring large-cap growth over the small-cap growth names that Cathie Wood tends to target, but ARKF could be a cryptocurrency play here.

This fund only owns Coinbase as a direct crypto play and doesn't own the Grayscale Bitcoin Trust (GBTC) or Canadian bitcoin ETFs in the way that other ARK ETFs do, but it could benefit from a wave of sentiment into the fintech space in general. SEC Chair Gary Gensler recently made a fairly abrupt shift in what originally was the regulatory body's pretty firm stance against bitcoin ETFs. His latest statement indicated that he's willing to consider filings using futures contracts under the preferred ETF structure (as a '40 Act fund and not a '33 Act fund, but we won't get into those weeds here). Prior to a few weeks ago, I thought there was virtually no chance we'd see a bitcoin ETF approved in 2021. Now, I'm hearing some people suggesting that we could see an approval as early as October.

If we actually get a bitcoin ETF in the 4th quarter of this year and retail investors begin flooding in, I'd expect the interest in the fintech space to rise quickly. Again, this won't resemble any kind of direct crypto investment, but a bitcoin ETF would likely bring buyers into this space as well.

Global X Nasdaq 100 Covered Call ETF (QYLD)

source: ETF Action

source: ETF Action

About two weeks ago, I wrote about a trio of covered call ETFs from Global X. Their biggest selling point is that all three currently offer yields between 10% and 12%. Covered call strategies have gotten a lot of attention as a way to generate high yield in a world where both long-term Treasuries and the S&P 500 are yielding less than 2%.

Investors have certainly taken notice. The three combined for around $1.8 billion at the beginning of 2021, mostly coming from QYLD. Today, that number is around $5.6 billion.

The catch with covered call ETFs is that they only tend to perform in a specific set of circumstances. If you're looking at them as a pure yield vehicle, they can make some sense, but you have to understand that you're giving up virtually all upside capital growth potential in exchange for it. If the Nasdaq 100 rises in value over time, the calls that are written within the fund will be called away and you'll be forced to sell at below market prices. Even if the index doesn't rise, but it has a fair amount of volatility to it, those shares likely get called away again, because they still spend enough time in the in-the-money state to be exercised.

In order for covered call strategies to perform well, we need to see a sideways or slightly downward trending market with low volatility. I don't see either of those happening.

Overall market volatility is still relatively low, save for last Monday's sharp drop, but I think the upcoming debt ceiling fight is going to spike volatility in both stocks and bonds. I'd definitely wait until after all that dust has cleared before reconsidering funds, such as QYLD. Now isn't the time to reach for yield.

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