On a historical basis, August usually isn’t a good month for stocks, but August 2019 could enter rarefied air as one of the worst months on record for stocks. As of Friday, Aug. 23, the S&P 500 was down more than 5% month-to-date. It’s popped a bit since then, but the average August decline for the benchmark U.S. equity gauge over the past 20 years is a mere 0.10%.
With just a week left in August, don’t expect a significant reversal of fortune, especially not when President Trump’s anti-China rhetoric is reaching new heights. China isn’t innocent in this deal, either. Beijing is promising to boost tariffs on American-made products and that gambit isn’t paying dividends for Chinese markets, either.
In this piece, we’re looking at some of the worst ETFs and there are plenty of China offenders. Month-to-date, the iShares China Large-Cap ETF (NYSEARCA:FXI), one of the largest China funds trading in the U.S., is off 9.05%, easily putting it in “worst ETF” territory.
Investors do not need to avoid equities altogether, but this is an environment that rewards defense and many of the worst ETFs aren’t that. Here are some of the ETFs to avoid over the near term or considering removing from your portfolio before larger losses mount.
Technology Select Sector SPDR (XLK)
Expense ratio: 0.13% per year, or $13 on a $10,000 investment.
This is not an example of picking on a particular ETF. With the market declining due to trade tensions and technology being the largest sector weight in the S&P 500, any fund tracking the sector could be in “worst ETF” territory over the near term. The Technology Select Sector SPDR (NYSEARCA:XLK) just happens to be the largest ETF dedicated to tech stocks.
Apple (NASDAQ:AAPL), XLK’s second-largest holding, epitomizes the headwinds facing XLK and rival funds in an environment where the U.S. and China are at odds. President Trump can rally his base by demanding American tech companies bring operations back to the U.S. and reduce dependence on China, but making that effort actually come to life is improbable. Regarding Apple, for every $10 in revenue it generates, China accounts for $2.
“Companies like Apple rely on contract manufacturers in China for many reasons,” reports Barron’s. “The cost and abundance of labor is one reason, but so is capacity and manufacturing sophistication. As much as the White House might like companies like Apple to extricate themselves from China, what he is asking would be both almost impossible and economically disastrous.”
iShares Russell 2000 ETF (IWM)
Expense ratio: 0.19%
As is the case with XLK above, the iShares Russell 2000 ETF (NYSEARCA:IWM) is not being picked on here. IWM is joined in the worst ETF club at the moment by a slew of its small-cap rivals. I’m simply including IWM here because with more than $39.2 billion in assets under management, it is the largest small-cap ETF.
Typically, international trade tensions would actually be an impetus for embracing domestic small caps because these companies generate the bulk of their revenue within the U.S. Said another way, the August struggles of IWM and rival small-cap funds are not only disappointing, but concerning.
The worst ETF status of standard small-cap funds like IWM can be attributed to the funds’ large weights to the financial services sector. That group has been punished by declining interest rates and smaller financial companies are even more vulnerable to that trend than their large-cap brethren. Making matters worse for small-cap funds is that if markets continue flailing, the Federal Reserve is likely to deploy more rate cuts, so even if large caps bounce back, smaller stocks could continue languishing.
SPDR S&P Retail ETF (XRT)
Expense ratio: 0.35%
The SPDR S&P Retail ETF (NYSEARCA:XRT) is down almost 10% this month. Alone, that’s a qualifier for worst ETF status, but long-term retail trends do not bode well for XRT. Put simply, XRT has too much exposure to struggling brick-and-mortar retailers and not enough to hot corner of retail: e-commerce and online.
I’m not saying Amazon (NASDAQ:AMZN) is going to put every brick-and-mortar retailer out of business, but the expected growth of online retail is a drag on XRT and its worst ETF status is only cemented by large exposure to struggling department store operators. A recent spate of earnings reports confirm that department and outlet stores are in under significant pressure.
“Second-quarter results in this channel still fell short for many,” said Citigroup analyst Paul Lejuez in a recent note. The strong U.S. consumer “underscores that the pressure in this channel is structural.”
VanEck Vectors Gaming ETF (BJK)
Expense ratio: 0.66%
The VanEck Vectors Gaming ETF (NYSEARCA:BJK) isn’t the biggest industry fund on the market, but it bears noting in this conversation because the U.S. and China combine for about 59% of the fund’s geographic weight. What that means is significant exposure to Macau, the world’s largest gaming mecca and that equates to vulnerabilities for this fund because the largest US-based casino companies are also among the largest Macau operators.
Macau is being pinched on multiple fronts, including the US/China trade war and the now long-running protests in Hong Kong, which have hampered travel to the gambling hub. If China’s economy noticeably slows, that will keep VIPs out of Macau, confirming BJK as a worst ETF.
Making matters worse is that the domestic regional operators found in this fund, although they have no China exposure, are also being punished. That could portend some value with BJK down the road as markets reassess certain casino firms, but now isn’t the time to be rushing into this fund.
First Trust Materials AlphaDEX Fund (FXZ)
Expense ratio: 0.64%
The materials sector is one of the smallest weights in the S&P 500, but it has been one of the biggest losers this month. Just look at the First Trust Materials AlphaDEX Fund (NYSEARCA:FXZ), which is one of August’s worst ETFs with a loss of 12%.
Several marquee companies in this sector are already talking about the ill effects the trade war will have on earnings and revenue, making FXZ and other materials highly undesirable over the near-term. China is just too important of a customer for many American chemicals and plastics producers to make FXZ a “buy” today.
Further hindering FXZ is its status a mid-cap ETF at a time when smaller stocks are out of favor. Investors looking for glimmers of hope with materials stocks will enjoy knowing that hedge funds are overweight the sector, but if FXZ is on your shopping list, keep it there because patience will likely lead to better prices here.
iShares PHLX Semiconductor ETF (SOXX)
Expense ratio: 0.46%
Trade wars spell trouble for tech stocks, but semiconductor names are among the most vulnerable. That is much is proven by the iShares PHLX Semiconductor ETF (NASDAQ:SOXX), which is lower by more than 9% this month. SOXX, which tracks the PHLX SOX Semiconductor Sector Index, has a standard deviation of 22.31% and has displayed considerable sensitivity to trade-related headlines, so its worst ETF status could be shed in short order. Properly timing that move is another matter.
“Chipmakers have been similarly volatile because of the trade war. The Philadelphia Semiconductor Index dropped 3.6% on Friday, and every member of the benchmark industry index was in negative territory,” according to Bloomberg.
Many SOXX components are suppliers to the controversial Chinese telecom firm Huawei. That company is blacklisted by U.S. regulators, a move that has stirred semiconductor companies into action with executives pleading with the White House to relax some of the Huawei restrictions. There’s the catalyst to get SOXX out of worst ETF territory, but no one knows when it’s coming.
Vanguard FTSE Europe ETF (VFK)
Expense ratio: 0.09%
The Vanguard FTSE Europe ETF (NYSEARCA:VGK) is performing mostly inline with the S&P 500 this month and while expectations are running high that central banks across Europe are poised to spring into action, that may be a case of too little too late to help many of the region’s long-slumbering economies.
Adding to VGK as a worst ETF contender is that European stocks are basically value plays and value is mostly out of style. Developed Europe has been inexpensive relative to the U.S. for years and global investors have hardly seemed to care.
“According to FactSet data, the Stoxx Europe 600 was trading at 14 times forecast earnings, compared to the S&P 500’s 17 times, which represent a wider gap than its long-term average over the past decade,” reports ETF Trends.
Other reasons VGK is a near-term avoid: the specter of a hard Brexit (the UK is the ETF’s largest country weight), a recession in Germany and more political volatility in Italy.
Todd Shriber does not own any of the aforementioned securities.