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ETFs: Corporate earnings valuing cost cutting over growth, expert says

As earnings season nears its close, VettaFi has found that 80 percent of earnings beats can be attributed to cost-cutting measures and not revenue growth. ETF Think Tank Director of Research Cinthia Murphy sits down with Yahoo Finance Live to talk about cautionary ETF plays as earnings season passes and investors pay closer attention to the Fed's interest rate decisions.

"The truth is they're beating because they're cutting costs, and that's not necessarily supportive of growth," Murphy says on earnings season, adding: "What we're seeing in the ETF space... people [are] slowly [trimming] that risk exposure and defensive plays are gaining momentum here because nobody knows what happens next."

Murphy outlines ETF strategies amid higher-for-longer interest rates, such as total market exposures, while also commenting on the narrative around the pending approval of a spot bitcoin ETF.

Video transcript

- All right, well, according to insights from VettaFi, 90% of the S&P 500 have reported results as we come to the end of yet another earnings season. And roughly around 80% of those companies are beating EPS expectations. As VettaFi notes however, the main driver for positive earnings has been cost-cutting and not revenue growth, which means individual stocks have not been responding well regardless of having strong earnings.

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Now, this can be a positive for sector ETFs since eight of the 11 sectors have reported year over year earnings growth. As part of the ETF report brought to you by Invesco QQQ, let's bring in ETF Think Tank director of research, Cinthia Murphy, to discuss this more. Good to see you, Cinthia. So talk about the environment that we're in here as we take a look at this tail end of earnings season.

CINTHIA MURPHY: Hi, Rachelle. Yeah, it's a tricky time right now to be an investor because what we've seen work so far this year have been things that we didn't expect would have a strong year. Things like some aggressive growth names, things like crypto and digital asset-related things, everything that touches artificial intelligence. So have tech have a heavy tech, heavy growth, heavy risk.

But now as we're going through this earnings season, I think we're starting to get a sense that even on the surface, the numbers look good. Even on the surface, companies are beating these estimates. The truth is they're beating because they're cutting costs. And that's not necessarily supportive of growth. That doesn't suggest that the underlying reason for these performances is good. It really is just tightening the belt.

So what we're seeing in the ETF space, we're seeing people slowly trim that risk exposure, and defensive plays are gaining momentum here because nobody knows what happens next. Nobody expected growth to perform this well this year, so there's always the off chance that this continues going.

But it looks like investors are opting to take a little more cautious tone as they go forward waiting to see what happens, waiting to see what the Fed says in the next few days out of Jackson Hole, everybody's looking for the next inkling of what's the next shoe to drop. And can we turn this around or are we just going to go down into a recession?

- And of course, ETFs are designed to help manage in different sorts of economic environments. So looking at some of the ones that you're seeing of the most interest, the ones that you would recommend perhaps. And when you see this higher for longer interest rate environment, what are the standouts for you?

CINTHIA MURPHY: There's really three plays that you can consider now and that we're seeing people put money into. So if you have a higher for longer rate, you're being really rewarded to just sit in cash, because cash is yielding now above 5%. And by cash, I mean like your really short-term dated bonds.

So from the bond market exposure, we're seeing most investors and advisors investing for clients. They're really heavily allocated to the really short end of the curve because you don't have really much duration risk there to worry about. So higher rates don't really impact too much your bonds. But you're picking up a ton of yield, so it's a safe place to be.

Now, if you are looking to participate, to stay invested on the equity side and you're really concerned about this risk, the tough thing is what is it that's going to work? In theory, higher rates should be really favorable for value stocks. But this year, we've seen growth outperform value. So you are in this conundrum of trying to guess what should happen. So more defensive plays tend to work better here.

So things like either really diversified approaches since you don't know what value or growth is going to perform better, so just own it all. So things like total equity market type of exposure, things like VT, things like multi-asset class portfolios, like an ETF like Arepa is an interesting fund. It has four asset classes in there, risk weights, everything, so that you're having the lowest possible risk for full exposure.

And you have your dividend stocks, which were great performers in 2022, have been a little bit of underdogs this year. And all of a sudden, they're starting to come back in Vogue. And because people realize that these dividend portfolios, they are very under allocated attack, which means why they're dragging so much this year. But they allow your defensive sectors, your health care, financials, consumer staples, the spots that should hold out better if we have a higher for a longer period of higher rates, and we're kind of facing that economic uncertainty going forward.

- So then Cinthia, with a lot of people focused on defensive plays then, why are we still seeing so much interest when it comes to crypto and this never-ending road? At least at this point when it comes to seeing a spot Bitcoin ETF. What is the appeal there in this environment?

CINTHIA MURPHY: So the crypto thing is it's been a crazy space this year. And it has to do with just this excitement about, are we going to get a spot Bitcoin ETF? Most places in the world already have one. We don't have one as you know well. We've covered this, it's the space like, crazy this year.

And the support there is really just the market access story. If you get a spot Bitcoin ETF, a fund that actually in theory holds quote unquote, physical Bitcoin, you could open all sorts of advisor channels to access to Bitcoin ETFs. And that should be really supportive to Bitcoin and crypto assets because in Bitcoin, the story is a supply demand story. Supply of Bitcoin is finite, it's inelastic. So when you all of a sudden open a whole new channel of access to the crypto asset and it can't really just grow its supply, that is really supportive for prices.

So there's been all this excitement about what would a spot Bitcoin ETF potentially unleash in terms of demand and what that could do to price. That has really been an interesting story.

We specifically at our firm don't think we're going to see a Bitcoin ETF, spot Bitcoin ETF this year. We think there's a lot of regulatory hurdles that still have to be overcome. But the point is all the excitement is about that, is that whole new channel of demand that could come in and what that could translate in terms of price action for crypto assets.

- Well, the crypto loyalists are certainly still holding on for dear life for now holding out hope that that will at some point become a reality. A big thank you there to ETF Think Tank director of research, Cinthia Murphy. Thank you so much.

CINTHIA MURPHY: Thanks for having me.