7 Ways to Play the June Rate Hike (and Fakeout) with ETFs

In fact, under the surface, investors have been jumping back to some former hot spots in the market as the possibility of a rate hike mounts. However, as hawkish expectations grow, so too does the possibility of the Fed pulling the rug on investors; that is to say, if policymakers were to hold off from announcing a rate hike, many might find themselves unprepared by being over-positioned one way or another in their portfolio for rising rates.

Consider four ETF allocation ideas below in anticipation of a June rate hike, as well as three contrarian trades in the event of a “no hike” surprise.

Higher rates are synonymous with improving profitability for financials. The market is expressing its renewed love for the sector judging by the recent rally; for starters, the broad-based (XLF A), and its industry-specific brethren (XLFS ), have been the best performers from the sector lineup over the past 5-days (as of 5/24/16), gaining 2.93% and 3.35% respectively compared to (SPY A) up less than half of that (+1.47%).

As long as the bank stocks don’t get too far ahead of themselves before the Fed has a chance to deliver on the rate hike on June 15, then XLF, XLFS, and other Financials and Bank ETFs should outperform.

Talks of rising rates are reminding investors that tightening monetary policy corresponds with economic strength. As such, former tech (XLK A) and internet (FDN B+) leaders are back in the spotlight given their appeal among growth-seeking investors; after all, the internet names especially have proven capable of thriving despite a fragile macro environment.

Other ways to play include Nasdaq (QQQ A-), social media (SOCL C+), and software ETFs.

If hawkish expectations persist and the Fed doesn’t disappoint then it’s likely that dollar-denominated assets will come into favor after being shunned from the start of the year through April. This means a potential return of buyers to Currency-hedged ETFs along with outperformance for dollar-denominated bond ETFs like emerging market favorites (EMB A-) and (PCY A).

Read also Why Currency-Hedged ETFs have Gone from Love to Shunned.

Though often overlooked by many, the municipal bond market offers a unique combination of selling points. First and foremost, this asset class is beloved among investors in high-tax brackets given that the interest earned is exempt from federal taxes. Second, this asset class sits fairly high along the credit quality spectrum, and last but not least, there’s a decent yield to go along with that solid investment grade profile.

The biggest fund in the space (MUB A+) offers a 2% annual yield; and on the high-yield end of the spectrum lies (XMPT B) with a 4.93% annual distribution rate.

For further reading on municipal bonds, check out The Right (and Wrong) Way to Tweak your Bond Exposure.

Prior to the recent sell-off, from the start of 2016 through May 2nd, gold (GLD A-) and miners (GDX B+) of the yellow metal were up a stellar 21% and 85%, respectively. Since the aforementioned peak, these two have tumbled 5% and 13% respectively, leading many to wondering if this is a buyable dip or the gold rally dying. We’ll only know in hindsight.

What’s clear is that rate hike expectations are mounting, which leaves room for great disappointment if the Fed doesn’t deliver on the June announcement in the same capacity which the market is pricing-in. Therefore, any hiccups in the bulls’ plans with regards to the rate hike could spark a steep rebound for gold and especially the more volatility miners.

On the same “no hike” surprise note, the high-yield EM bond asset class may be ripe for a pop as well. In the event that policy tightening expectations are dialed back, such ETFs should benefit from continued low-rated prompting investors to reach for juicer yields.

Furthermore, these funds should benefit from the added tailwind of a falling U.S. dollar, lifting the local currencies which the underlying debt holdings are denominated in.

Perhaps the most obvious contrarian play with regards to the pending hike is shorting U.S. equities, seeing as how they have been rallying on the hopes of improving economic conditions, and by extension, higher rates. There a number of inverse equity ETFs, with some of the most popular ones being -1x S&P 500 (SH A+), -3x Small Caps (TZA B+), and -1x Nasdaq (PSQ A).

Just because rate hike-related recommendations are in the news doesn’t mean your portfolio will necessarily benefit from them. If you’re a passive, long-term investor, any rate hike selloffs could be a great way to scale into some discounted asset classes. For nimble traders, the growing consensus that the Fed will absolutely raise rates at the June meeting is setting up some nice contrarian trades that could provide sharp returns in a short time frame if policymakers fail to deliver on expectations.

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