BSV Vanguard Short Term Bond

The first quarter proved to be spectacular for the major U.S. equity indexes with all three benchmarks, the S&P 500, NASDAQ and the Dow, reaching multi year highs. Many individual stocks added double digits in this time frame as well, making 2013’s Q1 one of the best first quarters for stocks in a long time.

Nevertheless, over the past few years, after a fairly good first quarter the markets tended to lose steam in the second quarter. However, the trend could reverse this year as the technical as well as fundamental pictures are largely skewed in favor of the positives (read Top Performing ETFs of the First Quarter).

Having said this it is important for the major catalysts like unemployment data, housing data, retail sales as well as corporate earnings to show an improvement in order that equities continue the positive trend in Q2.

Against this backdrop, let us consider three ETF strategies that have a high possibility of success now that we are in the second quarter:

1) Earnings are the Key: A focus on earnings ETFs

It is a very well known that earnings are the biggest force impacting stock prices. And this is probably the single biggest factor that would determine the course of direction for equities going forward.

It is true that the low expectation from 4Q12 earnings was one of the major catalysts behind the surge in equities. However, things are different this time around.

Recent economic data has been improving. This has raised the expectation bar from the 1Q13 earnings season which is about to begin shortly. And any disappointment on this front would surely upset the rhythm of the market—a dangerous situation indeed.

Still, one would imagine given the recent positivity from the economy that a good earnings season could be in the cards (see Focus on Earnings with These ETFs).

Fortunately, for investors seeking to play the earnings momentum, there are some products available in the ETF space. These ETFs are typically fundamentally weighted with earnings as their weights.

Actually, these products do minimize realized volatility by focusing on companies with strong bottom lines. They are, however, slightly more concentrated in a handful of companies having strong earnings, so there is a bit of risk there.

Nevertheless, for investors seeking an exposure in this space the WisdomTree Total Earnings ETF (EXT) makes a good play for a broad market earnings picture. Also, for investors looking for earnings play in the large, mid and small cap segment separately, EPS, EZM and EES are the respective ways to go.

In this regard it should be noted that the ETFs mentioned above are not meant for momentum plays in the short term. Instead investors seeking exposure in the earnings ETFs will be better served if the have a fairly long term horizon, and are only seeking profitable firms for their portfolios (read 3 ETF Strategies for Long Term Success).

2) Short Term Bond ETFs continue to be good conservative plays

Interestingly, short term bond ETFs have seen huge inflows in the first quarter this year especially compared to other fixed income ETFs. This is strong evidence against the possibility of a great rotation from bonds into stocks, at least for the time being.

This comes as a surprise amidst rising optimism and excitement in the equity markets. However, a closer analysis reveals that reason for their popularity lies in apprehension surrounding a major pullback in the equity markets.

This is especially true considering the present investment case for other safe haven instruments like long term treasury bonds and gold. While treasury rates at the longer end of the yield curve have been increasing, the ETFs tracking the longer dated bonds have been slumping due to their high interest rate sensitivity (read Time for the Convertible Bond ETF?).

Also, gold has been the victim of severe selling pressure from large players on account of stronger equities and a firm dollar. It also doesn’t help that the outlook for gold remains rather uncertain in the near term.

Therefore, it seems that short term bonds might have emerged as the new safe havens. This could well carry on into the second quarter as the apprehension and expectation surrounding an equity market pullback will be even more now that the benchmarks are trading near their all time high levels.

Thus short term bond ETFs could make for interesting conservative plays in case a pullback does occur even though the scope of high returns is pretty much negligible (see Four ETFs to Buy on the Market Pullback).

With this backdrop investors could look into ETFs with a large asset base and good liquidity. The Vanguard Short Term Bond ETF (BSV) with a yield of around 1.5% and an expense ratio of 11 basis points is an extremely attractive pick from this space. The iShares Barclays 1-3 Year Credit Bond ETF (CSJ) is another alternative that investors can consider.

3) U.S. dollar is likely to outperform

Thanks to the devaluation of the Japanese yen and the escalation of Eurozone woes, the U.S. dollar (USD) had gained in value. Also, the British pound has been witnessing serious depreciation versus the USD courtesy of its feeble growth outlook and credit rating downgrade by rating agency Moody’s in mid February.

Furthermore, this trend doesn’t seem to be reversing anytime soon as the strength in the U.S. dollar has been triggered more by weakness in other currencies rather than U.S. economic fundamentals.

Also apart from the British pound which is now severely oversold and could witness some strength in the near term, there is no major catalyst for a surge in other major currencies going forward (read British Pound ETF: Time to Buy?).

In this regard, investors could look into the PowerShares DB U.S. Dollar Index Bullish ETF (UUP) as an option to play the strength in the U.S. dollar in the second quarter, continuing the trend from the first quarter (see Can the Dollar ETF (UUP) Finally Break Out?). However, the product could witness some selling pressure presently as it has run up quite a bit in the first quarter. Still, its outlook for Q2 remains positive given the weakness in other markets.

Bottom Line

Markets might be at or near all-time highs, but that doesn’t mean that there isn’t value in the investing universe. There are plenty of low risk options out there that could be great picks in Q2, and especially for investors willing to search for interesting choices in the ETF world.

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VANGD-SHT TRM B (BSV): ETF Research Reports
 
ISHARS-BR 1-3CB (CSJ): ETF Research Reports
 
WISDMTR-ERN 500 (EPS): ETF Research Reports
 
WISDMTR-TOT ERN (EXT): ETF Research Reports
 
PWRSH-DB US$ BU (UUP): ETF Research Reports
 
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