ETF Wrap: Here are the ETFs to buy if ‘reflation’, not stagflation, plays out, says BlackRock’s head of iShares strategy

The good and the bad

An environment that resembles ‘reflation’

When ETF Wrap spoke to Chaudhuri back in July, inflation was the hot theme and while that concern hasn’t abated the notion of 1970s style stagflation has started to cross the lips of some economists and analysts lately.

In her most recent research outlook, Chaudhuri says that she doesn’t subscribe to the notion that the U.S. economy will find itself in the throes of stagflation. Instead, she argues that the economic environment “resembles ‘reflation’ more than ‘stagflation.’” Here’s how she describes it:

The term stagflation was popularized in the 1970s when the U.S. experienced a 16-month recession and double-digit inflation. The recent move in higher yields amid an equity market decline, supply constraints and shortages of various commodities across the world have left many to question if we are entering another stagflationary environment. In our view, calls for stagflation are misplaced.

The analyst says that U.S. economic growth is healthy. The third and final reading of second-quarter GDP showed that the U.S. economy grew at a 6.7% annual pace, largely in line with expectations. The researcher expects the economy to grow at 4% next year. On top of that, the data showed that a rise in consumer spending was slightly faster, at 12% and exports were raised to a 7.6% increase instead of 6.6%.

Chaudhuri says that the specter of inflation, however, isn’t going to go away but does see it “peaking close to 5% core [consumer-price index] early next year before moving lower.” Of course, that is still well above the Fed’s annual 2% target but suggests that it may be more transitory than sustained.

So what does an investor do in that environment? Chaudhuri says prepare to see inflation continue to play out through supply-chain bottlenecks, product and labor shortages and rising wages and invest accordingly.

The iShares analysts said aim for sectors that are less sensitive to rising wage costs, including technology companies, financials, consumer discretionary. Of course, the BlackRock executive highlights iShares products, including the iShares Exponential Technologies ETF
XT,
+1.33%,
the iShares U.S. Consumer Discretionary ETF
IYC,
+1.50%,
the iShares U.S. Financials ETF
IYF,
+0.71%
and the iShares U.S. Regional Banks ETF
IAT,
+0.50%,
but there are loads of other counterparts in the SPDR suite. Those include the SPDR S&P Regional Banking ETF
KRE,
+0.63%,
Technology Select Sector SPDR Fund
XLK,
+1.10%,
Consumer Discretionary Select Sector SPDR Fund
XLY,
+1.82%
and the Financial Select Sector SPDR Fund
XLF,
+0.60%.
Those funds can even be cheaper at times if that is a key consideration for you. (That said, CFRA‘s Todd Rosenbluth is always reminding us that fees shouldn’t be the only arbiter in picking an exchange-traded product.)

Semiconductor funds also may be a good place to play shortages. She points to the popular iShares Semiconductor ETF, which has already seen some $1.5 billion in inflows this year.

If this environment is more reflationary, then Chaudhuri says that investors are better off focusing on value and quality names. She recommends that investors employ a “barbell” approach to investing, which implies buying assets that are higher risk to high-quality, safer picks but avoiding anything in the middle.

For strong value plays, Chaudhuri recommends iShares MSCI U.S.A. Value Value Factor ETF
VLUE,
+1.17%
and iShares MSCI Intl Value Factor ETF
IVLU,
+0.63%.
Vanguard Value ETF
VTV,
+0.82%
is considered by some a good value option and there are others.

Fidelity’s themes

Fidelity Investments kicked off a roster of four thematic ETFs that will trade on Cboe Global Markets’
CBOE,
+2.16%
BZX Exchange: Fidelity Clean Energy ETF, Fidelity Cloud Computing ETF, Fidelity Digital Health ETF, and Fidelity Electric Vehicles and Future Transportation ETF.

Greg Friedman, Fidelity’s head of ETF management and strategy, told ETF Wrap via email that the investment manager is “seeing interest in thematic investing from a wide range of investors, particularly younger ones, as they “look for opportunities to connect their investments to their personal interests, beliefs and values.”

ETF.com notes that the funds are priced cheaper than some rival funds in the same category. They all carry and expense ratio of 0.39%, which means that the investments will cost $3.90 annually for every $1000 invested. The popular iShares Global Clean Energy ETF
ICLN,
+1.10%
carries and expense ratio of 0.42% and First Trust Cloud Computing ETF
SKYY,
+1.60%
has an expense ratio of 0.60%, for example.

Thematic ETFs are fast becoming the new hot thing as providers aim to draw new clients, with precise strategic views and values. Provider ProShares last week launched a trio of funds: the ProShares S&P Kensho Smart Factories ETF
MAKX,
+2.88%,
the ProShares Big Data Refiners ETF
DAT,
+1.09%,
and the ProShares S&P Kensho Cleantech ETF
CTEX,
+3.46%.

Crypto funds

There isn’t a bitcoin-backed ETF but the universe of bitcoin and blockchain-related investment vehicles is growing geometrically.

Now you can add Invesco, one of the biggest operators of exchange-traded funds in the U.S., to the list of new providers. The fund provider joined with Galaxy Digital Holdings Ltd
BRPHF,
-0.89%
 
GLXY,
-1.62%
and Alerian S-Network to launch a pair of passively managed crypto and blockchain related ETFs, which could be a prelude to a suite of digital-asset investment funds.

The Invesco Alerian Galaxy Crypto Economy ETF
SATO,
-4.29%
and Invesco Alerian Galaxy Blockchain Users and Decentralized Commerce ETF
BLKC,

were trading in positive territory in their Thursday debuts.

John Hoffman, head of Americas, ETFs and indexed strategies at Invesco
IVZ,
+0.08%,
 was quoted by The Wall Street Journal as saying that the partnership with Galaxy was about “defining the new market.”

“It’s not just about getting the first bitcoin ETF to the market,” Hoffman said. “This is about expanding the horizon. We ultimately think we can define this new market.”

A number of fund providers and investors are still laboring to get a U.S.-listed ETF backed directly by bitcoin approved by regulator the Securities and Exchange Commission but have so far failed.

The Invesco ETFs aren’t pure plays into crypto but invest in companies and industries related to the nascent blockchain and digital-asset sector. Invesco Alerian Galaxy Crypto Economy ETF’s largest holding is BIGG Digital Assets Inc.
BBKCF,
+0.59%,
which develops software to track and trace crypto transactions. Northern Data AG
NB2,
+4.06%,
which provides infrastructure for high-performance computing, is the second-largest holding for fund. Northern Data’s infrastructure is used in bitcoin mining, blockchain, artificial intelligence, among other areas. Bit Digital Inc.
BTBT,
-1.38%,
Square Inc.
SQ,
+4.46%
and MicroStrategy
MSTR,
+1.96%
round out the fund’s top 5 holdings.

Invesco Alerian Galaxy Blockchain Users and Decentralized Commerce ETF is made up of a similar mix of companies but in different proportions. A little over 50% of the Blockchain ETF’s holdings are information tech, compared with 63% for the crypto fund.

Both funds carry expense ratios of 0.60%, which is cheaper than competitor funds Bitwise Crypto Industry Innovators ETF
BITQ,
-0.29%,
with a 0.85% fee and Amplify Transformational Data Sharing ETF
BLOK,
-0.35%,
which is 0.71%. However, it costs more than the VanEck Digital Transformational ETF and Global X Blockchain ETF, which both have expense ratios of 0.50%.

CFRA’s Rosenbluth, head of ETF & mutual fund research, said that there is a simple reason why we are seeing more crypto funds emerge that are indirect plays on digital assets.

“There’s a long term shift toward the trend but there is less clarity who the big winners will be,” Rosenbluth told ETF Wrap via email.

“An ETF provides investors with the benefits of diversification relative to single stock ownership. In addition, the lack of a bitcoin ETF, whether of physical or futures based has made these thematic equity ETFs appealing,” the researcher said.

How to ride shipping

As supply chain issues remain in focus, forcing companies and individuals to pay more for goods, there may be another way to play rising inflation.

Shipping has become a flashpoint for investors as pricing pressures grow and backlogs increase. The Wall Street Journal reported that the cost of shipping containers across the ocean is surging and it continues to be a challenge to find long haul truck drivers. Those shortages have combined with surging energy costs and investors have apparently started to focus on at least one fund.

Breakwave Dry Bulk Shipping ET
BDRY,
-6.53%
is up 400% on the year and 8% already in October, FactSet data show. The fund offers exposure to freight futures and to a key cog in the wheel of the global economy: shipping. It is tiny at about $112 million under management and carries an pricey expense ratio at 3.76%. An even smaller fund, SonicShares Global Shipping ETF
BOAT,
+1.10%,
which was kicked off in August and has $11 million under management, also attempts to provide “pure-play exposure to the water transportation industry” and looks for globally listed companies “that derive significant revenue from cargo shipping, dry-bulk shipping, and oil and natural gas transport.”

The Sonic ETF is down 2% over the past 30 days while Breakwave is up 44% over the past monthly period.

No more ‘Vol-mageddons’?

Reports indicate that SEC Chair Gary Gensler is reviewing potential risks associated with complex, leveraged ETPs, which could have “systemwide” consequences for financial markets.

The SEC is considering potential rule changes to provide better protections for prospective investors in leveraged and inverse ETFs.

It is curious then that the SEC approved a pair of ETFs that mimic the VelocityShares Daily Inverse VIX Short-Term ETN and the VelocityShares Daily 2X VIX Short-Term ETN, which infamously imploded back in early February of 2018 after a period of quiescence in the market, with Cboe Volatility Index
VIX,
-6.57%
at or near record lows, busted out.

This time the new funds are structured as ETFs rather than exchange-traded notes, which is essentially a unsecured debt instrument issued usually by a bank, a fact that many investors weren’t entirely aware of back four years ago.

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