Picking Equity ETFs in a Down Market

The challenge is discerning whether funds are good long-term bets that are inexpensive or value traps.

Where do investment advisors and self-directed investors look for promising long-term equity ETF ideas when “everything” is down? 

As I pondered that recently, I thought of the iconic film “Good Will Hunting,” particularly a line delivered by Ben Affleck to his buddy in the film and in real life, Matt Damon.  

The message of the scene was that Affleck’s character hoped he’d go to pick up his friend for their construction job, and there would be no one home, since he had gone off to pursue a career that used his immense mathematics talent. Until that day, he’s just keep hoping. 

When you consider just how difficult it has been to find sustainable winners in the global stock market since the start of 2022, it has shades of that scene. 

We hope that one day we will determine there are segments of diverse set of equity market ETFs that will be the stuff of long-term success. It will, of course, arrive at some point. But history tells us that might be soon, it could be years, or somewhere in between. Because after a historically strong decade for equity ETFs, finding “trades” is a lot easier than something that won't simply cycle up and down.  

Consider this partial list of market segments that have lost money since the start of 2022, nearly two years ago: S&P 500, Nasdaq 100, Russell 2000 small caps, top 50 stocks by market cap, top 100 stocks and every one of the 11 sectors except for energy. As another famous line from the movie goes, “How about them apples?” 

ETFs on the Cheap  

Investors with very long-time horizons can look at ETFs with statistically cheap portfolios, such as these that all have forward price-to-earnings ratios of less than 12 t and dividend yields of at least 3.9%.  

The Invesco KBW Bank ETF (KBWB) yields 4.3% and sells at 8.4 times forward earnings. But given the bank calamity from earlier this year, can those earnings be trusted? Sometimes, things are cheap for a reason. 

Master limited partnership ETFs like the Alerian MLP ETF (AMLP) have been a popular shopping spot for yield-hungry investors. That portfolio yields 7.6% and sells at 10.8 times earnings. But in an environment where interest rates may still not be done climbing, investors have to decide if the extra yield is worth a basket of equities tied to demand for oil and gas and U.S. Treasuries.  

A pair of broad-based, dividend-focused ETFs offer the same dilemma. The SPDRA Portfolio S&P 500 High Dividend ETF (SPYD) owns the 80 S&P 500 stocks with the highest yields and with an overlay to avoid too much concentration in any one sector.

The only other time when SPYD yielded more than its current 5.4% was back during the onset of the pandemic when stock prices plunged temporarily. However, that was also a time when dividend payments from several prominent public companies were suspended or even eliminated.  

And the Invesco Dow Jones Industrial Average Dividend ETF (DJD) yields 3.9%, offering a nice yield-weighted version of the classic Dow 30 (minus the Dow stocks that do not pay dividends). But even as DJD’s yield is nearly double the 2.0% yield of the standard price-weighted Dow, that index has lagged the S&P 500 and Nasdaq 100 in recent years.  

Long-Term Winners or Value Traps 

It might be interesting to mark our calendars to a couple of years from now to see which, if any, of these ETFs turned out to be long-term value buys instead of value traps in a bear market still keeping stocks below their 2022 opening levels. 

Ben Affleck’s character in “Good Will Hunting” had the hope and the patience that one day, he would show up to an empty house. Amid a second rough year in a row for most of the equity market, investment advisors and investors continue the hunt for value that is more than just statistical, and that can lead to strong, sustainable returns.