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

Is the market looking bullish or bearish here? There's a case to be made for both sides.
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This market is starting to look really interesting, as in I'm not sure which way it's going to head next. If you look purely at last week's equity market returns, there are two distinct narratives being crafted - one bullish and one bearish.

Since most investors pay attention to the S&P 500 first and foremost (or entirely), we'll start there. Within the index, the top four performing sectors were real estate, utilities, consumer staples and healthcare. All of these are defensive-oriented sectors, which typically outperform when investors are being cautious. Considering that the S&P 500 hasn't experienced so much as a 5% pullback all year, outperformance of defensive sectors at the expense of cyclicals can probably be read into as a quasi-correction. If you look at this trend in isolation, you could easily conclude that last week had a bearish lean.

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But then look what happened in small-caps. Last week, the Russell 2000 performed mostly on par with the S&P 500, but over the past two weeks, it's outperformed by about 3.5%. More than that, the composition of this outperformance is different than that of large-caps. Among the outperforming sectors among small-caps were financials, tech, energy and materials. The defensive sectors also did comparatively well, but these four all of a growth or cyclical theme. If you take this trend in isolation - small-caps outperforming large-caps and growth/cyclical outperforming the index - you could easily conclude that last week had a bullish lean.

What is Treasuries telling us? Government bonds have been roughly flat over the past month, so there's not much of a signal in either direction. This, of course, follows a stretch dating all the way back to March where the 10-year yield went from as high as 1.77% to as low as 1.12%, fueling solid gains for long-term Treasuries despite the fact that U.S. stocks were rising at the same time. The rally in Treasuries appears to be over for the time being, but which direction the next leg moves in is unclear.

The jobs report was a net negative for the economy - both Treasuries and the dollar responded about how you'd expect, but equities mostly shrugged off the disappointing number. Part of the lack of a pullback in stock prices could be that the report, which the Fed looks closely at in making policy decisions, raises the possibility that the central bank will delay its tapering plans, possibly pushing its start all the way into 2022. As we've seen time and again, more stimulus and liquidity tends to be a positive for stock prices. A later taper but weaker jobs market may have just cancelled each other out as far as stock prices are concerned.

The holiday-shortened week will be light on new economic numbers, but we will get the latest round of producer price data on Friday. Expectations are for a year-over-year increase of 8.2%, up from 7.8% last month. Despite this number, which would be the highest in more than a decade may not do much to challenge the Fed's "transitory" narrative. Breakeven rates suggest that inflation expectations have flatlined and most surveys show money managers believe that overall inflation will still return to the 2-3% range by the 2nd half of 2022.

At this point, there are several data points suggesting that some degree of caution is warranted here, but none that are really flashing outright warning signs. We'd probably need at least a few more months of high inflation readings before we can start talking about the Fed pulling the rate hike calendar forward. The best bet for the next event to watch will be the debt ceiling discussion. That genuinely has the chance to shock the markets and, while we know that Congress will eventually raise the debt ceiling again, a repeat of 2011 would send a shock throughout the financial system.

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

WisdomTree China ex-State Owned Enterprises ETF (CXSE)

source: ETF Action

source: ETF Action

Yes, I realize that it was just last week that I suggested investors avoid the Invesco China Technology ETF (CQQQ), so why would I offer up CXSE as one of the ETFs to buy this week? Last week, I noted that "the country is still imposing lockdown measures, there are still substantial supply chain and shipping issues and the strength of the nation's recovery is in some question." All of those points are still very valid and remain headwinds for the country and its investors. However, I want to approach my view on CXSE this week from a couple of different standpoints.

First, Chinese stocks have had an incredible run over the past two weeks. During that time, the SPDR S&P 500 ETF (SPY) gained 2.2%, but the iShares MSCI China ETF (MCHI) was up 8.9%. The KraneShares CSI China Internet ETF (KWEB), perhaps the poster child for the China equity market blowup, rebounded an astounding 19.5%. This may ultimately prove to be a dead cat bounce and these funds may end up giving back some of these gains, but I'd encourage investors to pull back and look at the larger picture.

Even after these gains, MCHI is still 25% below its high. KWEB is still 49% below its high. It's easy to look at the huge gains over the past two weeks and feel like you missed out, but these are still bargain basement deals at these prices. Short-term risks are still high. The Chinese government may step in again with more new regulations that could hamper the economy. The COVID economic recovery looks like it may be slowing faster than anticipated. These are still very real risks, but it looks like a lot of the worst case scenarios for China stocks are priced in. If you're considering adding China or emerging markets exposure to your portfolio (remember, China represents about 30-40% of most of the major indices), now might be the time to consider it. Sure, short-term risks are elevated and may be for a while yet, but if you're willing to hold for the longer-term and ride out some of the likely volatility, there's the potential for solid returns buying in here.

I think the right way to approach investing in China is through CXSE. State-owned enterprises generally exist for the good of the public, not the investor. Their primary purpose is to provide some type of good or service that is available to all, such as banking or public utilities, but generally doesn't operate to generate a profit (although it can). In some cases, they can be non-profit altogether as we learned from the government's recent crackdown on the education sector. For the purposes of fulfilling CXSE's objective, it stays away from any company in which more than 20% of its shares are owned by the government. Think of it as kicking the communism out of your portfolio.

CXSE and its sister fund, the WisdomTree Emerging Markets ex-State Owned Enterprises ETF (XSOE) focus only on the capitalistic side of the nation's economy. It likely has a greater return potential than a fund that incorporates government-owned entities in its portfolio and avoids those companies that may come under undue influence from political activites.

Roundhill Sports Betting & iGaming ETF (BETZ)

source: ETF Action

source: ETF Action

If you're a sports fan like me, you can't wait for the NFL season to start this weekend (technically it starts on Thursday, but you know what I mean). Outside of maybe the NCAA tournament every year, no sport generates as much gambling interest as the NFL. With fans filling the stadiums again (all 32 teams have been approved for full capacity this season), it's going to feel like a "normal" season for the first time since before the pandemic began. That type of excitement is likely to fuel a lot of interest in daily fantasy and online wagering.

Speaking strictly from a financial standpoint, nothing that is going to happen on Sunday will be unexpected. Market watchers are expecting a lot of money to be wagered, but this is a very "feel good" and perception-oriented industry. It may only take a weekend of studio analysts making game picks against the line, getting fantasy football drafts completed before the opening kick-off and engaging in daily fantasy again for sports fans and investors to realize once more the potential in this space. Expect DraftKings and FanDuel to get a lot of attention.

As WisdomTree notes:

Screen Shot 2021-09-06 at 3.49.11 PM

Not to bring up China again, but this ETF also focuses on the online gaming industry and there is this little issue of China placing significant restrictions on youth gaming activities. Fear not, BETZ doesn't have any China exposure currently, so there shouldn't be any direct impact to the fund from this.

iShares U.S. Treasury Bond ETF (GOVT)

source: ETF Action

source: ETF Action

As I mentioned above, U.S. Treasuries have been mostly flat over the past month and the momentum that had built up since the March peak in interest rates appears to have faded. Even though we haven't seen it much in 2021, the persistent buying interest we've seen in equities throughout should, in theory, send bond prices in the other direction. The flatlining of government bond prices over the past several weeks could be signaling the early stages of a shift in the other direction.

Treasuries have been unpredictable if nothing else in 2021, which is one of the reasons I'd be hesitant to add new positions here (outside, of course, the fact that yields are already near record lows). I've mentioned before that the upcoming debt ceiling showdown could be the catalyst that sends Treasury yields higher. In the near-term, Treasury bond prices could rise in anticipation of overall market risks rising if a deal can't be struck well ahead of the point where the government runs out of cash. If that date gets dangerously close, investors could actually end up abandoning Treasuries for fear that a default is a possibility or that their interest payments could be delayed.

Back in 2011, the last time there was a major debt ceiling showdown, the 10-year Treasury yield fell 125 basis points over the course of about two months when U.S. debt got downgraded by Moody's. That, of course, resulted in gains for Treasuries, but there was a lot of yield volatility in the lead-up to this point.

We could see yields plunge again if things come to a head again like they did a decade ago, but it will almost certainly result in volatility. Given how unpredictably both stocks and bonds have reacted to events over the past year, a high volatility asset class might best be avoided for the time being.

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