Wall Street is witnessing extreme volatility since the start of the third quarter. While there is growing anxiety about a slowing U.S. economy, optimism over Fed rate cuts has rekindled investors' confidence in the stock market. Additionally, the latest bouts of strong data led to a renewed risk-on trade.

As such, the three major indices recouped most of the losses made early this month, with the S&P 500 and Nasdaq Composite Index turning positive for the month. The S&P 500 extended a six-day rally to 6.6% — the best performance in such a span since November 2022. Meanwhile, the volatility level represented by the CBOE Volatility Index, also known as the fear gauge, rapidly eased after closing at a four-year high last week (read: Low Volatility ETFs Shining Halfway Through Q3).

In such a scenario, investors should focus on high-quality investing. Quality stocks possess a sustainable competitive advantage and demonstrate consistent growth, profitability and operational excellence over time. While there are several funds available in the space, we have chosen the five most popular ETFs targeting the niche strategy. These are iShares MSCI USA Quality Factor ETF (QUAL Quick QuoteQUAL - Free Report) , Invesco S&P 500 Quality ETF (SPHQ Quick QuoteSPHQ - Free Report) , JPMorgan U.S. Quality Factor ETF (JQUA Quick QuoteJQUA - Free Report) , FlexShares Quality Dividend Index Fund (QDF Quick QuoteQDF - Free Report) and SPDR MSCI USA StrategicFactors ETF (QUS Quick QuoteQUS - Free Report) .

Quality ETFs often provide a hedge against market volatility and uncertainty.

Current Market Trends

The latest upbeat data on inflation and retail sales has reassured investors, supporting the view that the world’s largest economy is heading for a “Goldilocks” scenario of contained inflation accompanied by resilient growth. U.S. annual inflation dipped below 3% annually in July for the first time since 2021 while retail sales registered the biggest increase in a year and a half, indicating resilient consumer spending.

This has spurred the bets that the Fed will cut interest rates at its upcoming September meeting. Traders now see a 75% chance of a 25-bps cut next month by the Fed and a 25% chance of a 50-bps reduction, according to CME's FedWatch Tool.

Lower interest rates generally lead to reduced borrowing costs, which help businesses expand their operations more easily, resulting in increased profitability. This, in turn, stimulates economic growth and provides a boost to the stock market.

However, the big technology companies, which are again leading the charge after a massive sell-off in early August, appear overvalued. Political uncertainty, ranging from the U.S. election in November to the prospect of increased Middle East tensions, continues to keep investors on their toes.

Why Quality?

We have highlighted some solid reasons for investing in quality stocks.

Lower Volatility: Quality stocks tend to exhibit lower volatility compared to the broader market. Their robust business models and financial strength make them less susceptible to market fluctuations, leading to a smoother investment journey.

Defensive Nature: During economic downturns, quality stocks often prove more resilient as they have strong balance sheets and low levels of debt and cash reserves to help them tide over challenging times.

Value Preservation: In uncertain or declining market environments, quality stocks can serve as a relative safe haven, preserving capital better than more speculative or lower-quality investments.

Strong Brand and Moat: Quality companies often possess strong brands and competitive moats, which protect them from competition. This can lead to a sustainable competitive advantage, ensuring long-term profitability.

Long-Term Outperformance: Historically, high-quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term. This is because quality companies have strong fundamentals that can weather economic downturns better than their weaker counterparts.

Consistent Profitability: Quality companies tend to have a high return on equity (ROE), return on invested capital (ROIC) and profit margins. These are indicators of a company's ability to generate profit consistently.

Compounding Effect: Betting on quality companies allows investors to benefit from the power of compounding. As these companies consistently grow their earnings and reinvest them, shareholders can achieve exponential returns over time.

Transparency and Governance: High-quality companies usually have transparent financial reporting and sound corporate governance. This reduces the chances of any unwelcome surprises and can potentially reduce investment risk.

Growth Potential: Even if they are established leaders, many quality companies still have significant room for growth, especially if they operate in expanding industries or have opportunities to penetrate new markets.

Dividend Payouts: Quality companies often have a history of paying consistent dividends, providing a source of income for investors. Moreover, since they are usually in a strong financial position, there's a good chance for steady or even increasing dividend payouts in the future (read: 5 Dividend ETFs Crushing the Market).

ETFs to Invest

iShares MSCI USA Quality Factor ETF (QUAL Quick QuoteQUAL - Free Report)

With an AUM of $47 billion, iShares MSCI USA Quality Factor ETF provides exposure to large and mid-cap stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index. QUAL holds 125 stocks in its basket and charges 15 bps in annual fees. It trades in an average daily volume of 986,000 shares and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook (read: 5 Safe ETF Zones to Invest in Amid Rekindled Recession Fears).

Invesco S&P 500 Quality ETF (SPHQ Quick QuoteSPHQ - Free Report)

Invesco S&P 500 Quality ETF tracks the S&P 500 Quality Index, a benchmark of S&P 500 stocks with the highest-quality score based on three fundamental measures such as return on equity, accruals ratio and financial leverage ratio. Holding 102 stocks in its basket, Invesco S&P 500 Quality ETF has amassed $10.4 billion in its asset base and trades at an average daily volume of 1 million shares. It charges 15 bps in fees per year and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

JPMorgan U.S. Quality Factor ETF (JQUA Quick QuoteJQUA - Free Report)

JPMorgan U.S. Quality Factor ETF provides domestic equity exposure with a focus on companies with strong quality and profitability characteristics and the potential to enhance returns. It tracks the JP Morgan US Quality Factor Index and holds 278 stocks in its basket. JPMorgan U.S. Quality Factor ETF has amassed $4.5 billion in its asset base and charges 12 bps in fees per year. It trades in an average daily volume of 456,000 shares.

FlexShares Quality Dividend Index Fund (QDF Quick QuoteQDF - Free Report)

FlexShares Quality Dividend Index Fund is designed to provide exposure to a high-quality income-oriented portfolio of long-only U.S. equity securities, with an emphasis on long-term capital growth and a targeted overall beta that is similar to that of the Northern Trust 1250 Index. QDF is home to 134 stocks in its basket and charges 37 bps in fees per year. FlexShares Quality Dividend Index Fund has accumulated $1.8 billion in its asset base and trades in an average daily volume of 43,000 shares. It has a Zacks ETF Rank #3 with a Medium risk outlook.

SPDR MSCI USA StrategicFactors ETF (QUS Quick QuoteQUS - Free Report)

SPDR MSCI USA StrategicFactors ETF offers exposure to stocks that combine low volatility, quality and value factor strategies. This is done by tracking the MSCI USA Factor Mix A-Series Capped Index. SPDR MSCI USA StrategicFactors ETF holds 602 stocks in its basket and charges 15 bps in fees per year from investors. It has attracted $1.8 billion in its asset base and trades in an average daily volume of 26,000 shares. QUS has a Zacks ETF Rank #3 with a Medium risk outlook.