Tag: Government debt

Here’s where ETF investors could turn to hide as Treasurys sell-off upends U.S. stocks

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Hello! This is MarketWatch reporter Isabel Wang bringing you this week’s ETF Wrap. In this week’s edition, we look at how ETF investors can navigate the choppy financial markets which remain on edge after a sell-off in U.S. government bonds drove long-term borrowing costs to the highest level in more than a decade, undercutting stock prices.

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A renewed rout in the U.S. government bond markets that sent the yield on the 10-year Treasury bond to 16-year highs as a new era of higher-for-longer interest rates takes hold, is leaving ETF investors scrambling for the exits on a wide range of exchange-traded funds in the past week, most notably the iShares 20+ Year Treasury Bond ETF
TLT.
 

TLT, one of the most popular fixed-income ETFs that tracks a market-weighted index of the U.S. Treasury bonds with maturities of 20 years or more, earlier this week suffered its lowest close since the early days of the 2007-2009 financial crisis. The yield on the 10-year Treasury 
BX:TMUBMUSD10Y
slipped 2 basis points to 4.715% on Thursday, after reaching 4.801% on Tuesday, its highest closing level since Aug. 8, 2007, according to Dow Jones Market Data.

See: Bond investors feel the heat as popular fixed-income ETF suffers lowest close since 2007

The bond market, particularly the U.S. Treasury market, has historically been less volatile and and has often performed better than other financial assets during economic slowdowns. However, that doesn’t mean bonds don’t come without their own risks.

Rising yields reflect a diminishing price for the securities when interest rates rise, and hit existing holders of Treasuries.

See: Rising Treasury yields are upsetting financial markets. Here’s why.

The surprising strength of the U.S. economy, as demonstrated by this week’s labor-market data, coupled with hawkish talk from Federal Reserve officials indicating the central bank may need to keep tightening monetary policy, have led to the bond sell-off this week.

Meanwhile, a positive Treasury term premium, or the compensation that investors require for the risk of holding a Treasury to maturity, have also contributed to a steep sell-off as a ballooning U.S. budget deficit and the Treasury’s need to issue more debt have pushed Treasury prices to 16-year lows.

TLT
TLT
has fallen over 50% since its peak in August 2020, according to FactSet data. The losses are “pretty much” what the equity-market loss was from peak to trough during the global financial crisis, said Tim Urbanowicz, head of research and investment strategy at Innovator ETFs. 

“It is not insignificant… It really makes you think about how you’re doing risk management because you can’t have the piece of the portfolio that’s supposed to be the risk mitigator falling the worst we’ve ever seen in the equity-market fall. That’s a big issue,” Urbanowicz told MarketWatch. 

That’s why ETF investors have very few options when developing or adjusting their asset allocation play in the higher-for-longer rates environment, but there are still some shockproof assets for safety, according to ETF strategists. 

Ultra short-term bond funds 

ETF investors that still favor bonds can consider hiding in ultra short-term bond funds to avoid duration risk as the Fed may still need to raise interest rates to curb inflation by the end of 2023, said Neena Mishra, director of ETF research at Zacks Investment Research. 

The SPDR Bloomberg 1-3 Month T-Bill ETF
BIL,
which tracks all publicly issued U.S. Treasury Bills that have a remaining maturity of less than 3 months and at least 1 month, offers a yield of 5.43%. The fund attracted over $1 billion of inflows in the week to Wednesday, the largest inflows among over 800 ETFs that MarketWatch tracked in the past week, according to FactSet data. 

Meanwhile, Mishra said investors who want active management with “better navigation to the markets” can consider the JPMorgan Ultra-Short Income ETF
JPST,
which is an actively managed fund that invests in a variety of debts including corporate issues, asset-backed securities, and mortgage-related debt as well as U.S. government and agency debt. JPST recorded $15 million of inflows in the past week and has yielded 5.76%, according to FactSet data. 

Flows into longer duration bonds, utilities sector

Despite the bond rout hitting the popular TLT fund hard as the 10-year Treasury yield surged, some retail traders have already started to buy the historic dip of the fund devoted to longer-dated Treasuries, said a team of Vanda Research data analysts led by Marco Iachini, senior vice president.

TLT attracted a total of $686 million flows in the week to Wednesday, ranking the 8th out of over 800 ETFs that MarketWatch tracked in the past week, according to FactSet data. 

Along with the strong “dip buying” in TLT, retail traders have also poured an “unprecedented amount” of capital into the utilities sector, Iachini and his team said in a Thursday note. The Utilities Select Sector SPDR Fund
XLU
recorded $141 million of inflows last week, according to FactSet data. 

“While purchases of utilities stocks are typically of a significantly smaller scale than purchases of tech stocks, the inflow seen over the past week is far larger than any other prior 5-day stretch, easily surpassing inflows into the sector at the onset of the Covid downturn,” the Vanda team said. “The flip side of this dynamic is that institutional investors have likely lightened up their utilities exposure during this bond sell-off episode, making the sector a potentially more appealing equity bet should rates be nearing a local peak.” 

See: Utilities stocks ‘decimated’ by rising rates fall into uncommon trading territory, Bespoke chart shows

Small-caps are ‘cheap for a reason,’ so don’t buy them too soon

Many small-cap stocks have traded at a significant discount to their larger-company counterparts, creating an attractive entry point for some investors who think the forward price-earnings ratio for small-caps are low enough to offer potential for outperformance in the longer run. 

However, small caps
IWM
are by nature more sensitive to higher interest rates compared with a lot of the larger-cap stocks which have the ability to be “nimble” with strong cash flow, said Urbanowicz.

“It is really important right now not to just rely on a specific sector but really have that built-in risk management at the index level to take a lot of that guesswork out of the equation,” he added.

See: Small-cap ETFs may look attractive as recession concerns fade, but blindly chasing the rally is not without risk

Defined-outcome ETFs

That’s why Urbanowicz and his team at Innovator ETFs think the increasingly popular defined-outcome ETFs, or the “buffer” funds, could limit the downside risk and help investors navigate a stormy rates environment.

See: An ETF that can’t go down? This new ‘buffer’ fund is designed to provide 100% protection against stock-market losses

For example, the Innovator Equity Defined Protection ETF
TJUL,
the “first-of-its-kind” fund, aims to offer investors the upside return of the SPDR S&P 500 ETF Trust
SPY
to a 16.62% cap, as well as a complete buffer against its downside over a two-year outcome period. 

Meanwhile, the Innovator Defined Wealth Shield ETF
BALT
offers a 20% downside buffer on the SPY every three months, which is a “very shortened outcome period” and doesn’t require the equity market to actually go up for the strategy to appreciate a value, Urbanowicz said. 

“A big reason [to consider this strategy] is it gives investors a place to not only maintain equity exposure, but also to hide out because they [funds] have known levels of risk management that are in place,” he added. 

As usual, here’s your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good…

Top performers

 %Performance
YieldMax TSLA Option Income Strategy ETF
TSLY 		6.2
United States Natural Gas Fund LP
UNG 		2.0
Quadratic Interest Rate Volatility & Inflation Hedge ETF
IVOL 		1.6
Technology Select Sector SPDR Fund
XLK 		0.9
ProShares Bitcoin Strategy ETF
BITO 		0.9
Source: FactSet data through Wednesday, October 4. Start date September 28. Excludes ETNs and leveraged products. Includes NYSE, Nasdaq and Cboe traded ETFs of $500 million or greater.

…and the bad

Bottom performers

 %Performance
AdvisorShares Pure U.S. Cannabis ETF
MSOS 		-11.3
Sprott Uranium Miners ETF
URNM 		-10.6
Global X Uranium ETF
URA 		-10.2
VanEck Oil Services ETF
OIH 		-9.2
SPDR S&P Oil & Gas Exploration & Production ETF
XOP 		-9.1
Source: FactSet data

New ETFs

  • J.P. Morgan Asset Management Friday announced the launch of a new actively managed hedged equity ETF, JPMorgan Hedged Equity Laddered Overlay ETF
    HELO.
    The outcome-oriented ETF invests in U.S. large-cap equities with a laddered options overlay designed to provide downside hedging relative to traditional equity strategies.

  • Zacks Investment Management Tuesday announced the launch of the Zacks Small and Mid Cap ETF
    SMIZ,
    which seeks to generate positive risk-adjusted returns by investing in small and mid-cap companies.

  • Calamos Investments LLC Wednesday announced the launch of the Calamos Convertible Equity Alternative ETF
    CVRT,
     the first product of its kind to provide ETF investors with targeted access to equity-sensitive convertibles.

Weekly ETF Reads

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With debt ceiling, default threat, these are banking moves every small business should be making

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U.S. President Joe Biden hosts debt limit talks with House Speaker Kevin McCarthy (R-CA) in the Oval Office at the White House in Washington, May 22, 2023.

Leah Millis | Reuters

Politicians often like to say that small businesses are the engine of the economy, but if that’s the case, the high-stakes poker game over the debt ceiling that is being played by the Republican-led House and Biden administration is risking a major stall out.

And the uncertainty about what is supposed to be most certain of all — the U.S. government paying its debt — comes on top of what already is a fraught economic environment for Main Street entrepreneurs.

“Small business owners right now are nervous,” said Asahi Pompey, Goldman Sachs Foundation global head of corporate engagement and president, at the recent CNBC Small Business Playbook virtual event. “They’re hearing a credit crunch, rising inflation. They’re hearing debt ceiling default. This is a scary time, and it is somewhat bewildering and challenging for small business owners.”

A warning from the Fitch credit rating agency about U.S. debt added fresh urgency on Thursday to the ongoing debt ceiling negotiations between the White House and congressional Republicans, with only seven days to go before the United States faced the threat of debt default, but a deal was reportedly close on Friday and the market rallied as investors bet the threat was receding.

Models suggest a default would do serious damage to the markets and economy, and the vast majority of small business owners (90%) want the government to avoid a debt default, according to a recent Goldman Sachs 10,000 Small Business Voices survey. With the battle in Washington, D.C. highly political, the survey results from small business owners are notable given that it’s a community that consistently skews conservative in demographic composition and political views.

How bad could it get? A 2013 estimate from Fed economists undertaken given a prior debt ceiling showdown projected a 30% decline in the stock market, a 10% drop in the value of the dollar, and a “mild” two-quarter recession. But mild still likely means millions of jobs would be lost and real GDP would take a big hit, according to the Brookings Institution.

The first to face the blows of this potential financial crisis will likely be small businesses that are paid directly by the federal government through contract work, which has happened in government shutdowns in recent history. But for all small businesses, already under the strain of a credit crunch that began with the biggest Fed rate increases in decades and a regional banking crisis that has made lenders much more conservative with new loans, a debt default would worsen an already deteriorating environment for growth.

Main Street already struggling to access credit

Almost half (44%) of small business owners already are experiencing “negative effects” in their ability to access credit, according to the Small Business & Entrepreneurship Council. And that matches the data from the recent CNBC|Momentive Small Business Survey which found owners saying they had lost confidence in banks as a result of the banking crisis, and even more to the point, almost half said it isn’t easy for them to access capital to operate.

Sixty-five percent of small businesses believe they will be negatively impacted if the debt ceiling is not raised, according to Goldman’s surveying, and most prominently through reduce access to capital.

In April of 2022, Goldman Sachs found that 77% of small business owners were confident in their ability to access capital. However, this past April, it found a full reversal, with the same percentage now worried about access to capital.

“Small businesses rely on small banks. And so we can’t overlook the fact that the banking crisis and concern over the last several months is driving some of that concern by small businesses about whether they’ll be able to really access capital,” Pompey said.

Along with the limited opportunities to obtain funding, small business owners would also face higher interest rates — even higher than rates that have already hit double-digit percentages for many business loans due to the Fed’s aggressive monetary policy that took rates from zero to 5% in a year.

“It’s a bit of a tightrope really that small business owners are trying to navigate. They want inflation to go down, but obviously they don’t want to have to pay more to access capital,” Pompey said.

Small business moves for an uncertain economy

All small businesses can do is prepare for the economic uncertainty that lies ahead. Control what they can control — i.e. not the debt ceiling talks — and Pompey says that means shoring up financial relationships and financial knowledge. In fact, even if a deal is reached, it is expected to only cover two years, and unless the political parties agree on a fix to make this issue go away for good, another debt ceiling crisis could be back before long. The moves small business owners should make now are ones that should be built into a regular, permanent business practice in advance of what are sure to be future economic uncertainties.

Pompey provided four key steps that small business owners should be taking in the current economic environment at the recent CNBC small business event.

1. Bank before you need it

When it comes time to access funding, bankers want to be able to know who their small business customers are and how to best understand the business and the impact they are making in their local communities. But that can’t happen if small business owners aren’t proactively managing that relationship before they actually need money.

Pompey recalled a small business owner advising her that “the worst time to meet a banker is when you need capital.”

It’s critical to know your banker and have an established connection with them in case there comes a time where you need to access funding, Pompey said. Calling your banker and updating them on what’s going on with your business are small efforts that can go a long way if the economy takes a turn for the worse.

That relationships needs to be re-established if its not been maintained, and then it is important to get in the habit of communicating on a regular basis with a bank, which also allows owners to share timely updates on business milestones.

2. Go deep into your numbers

Pompey said that time and time again she hears that small business owners feel a degree of discomfort when going into their financials. She suggested for owners to take a few days to really review their numbers, which will make them feel more empowered in this time of uncertainty even if it’s uncomfortable.

“The No. 1 thing that comes back to bite business owners later on tends to be something hiding in their numbers that they didn’t take the time to look at,” she said.

“Taking that time, which can be uncomfortable, to really go through your numbers is the first step to working on your business instead of in your business,” she added.

3. Know your customer

While coming face-to-face with financials in a slowing economy may be stressful, this is the fun part of the business, Pompey said. When small business owners understand their customer profiles and put themselves in the customers’ shoes, they can lean in on how to best adjust and pivot their businesses to meet the needs of customers.

4. Build a small business network

Pompey said that she hears over and over again from small business owners one thing: it’s lonely. As a result, having the proper support as well as opportunities to collaborate and share strategies or business programs are critical to success.

“Tap into your small business besties,” she said.

The Current State of Main Street in America

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