After a September in which investor enthusiasm drove strong ETF flows, sentiment returned to earth during a spooky October for the markets that saw the S&P 500 Index swing into correction territory. Cracks to the momentum trade that began to appear earlier this year widened considerably during the month, bringing risk assets broadly lower and close to flat or negative returns for the year.
ETF investors struggled to bring in assets in this environment, but were still positive for the month, drawing $4.8 billion in net new flows. This brings year-to-date net new flows for the ETF industry to $217 billion. After gaining ground during the third quarter on 2017’s robust ETF flows, October’s trickle reversed the trend. Today, we are 43% behind where we were at this time in 2017.
Risk Assets Sell Off and Investors Rotate to International
Where to begin? A host of factors impacted selling across markets last month. The International Monetary Fund dialed down global growth expectations, citing impending tariffs as a threat to projections. Technology shares, a key driver of the rally that pushed U.S. equities to record highs during September, experienced weakness on multiple fronts – Chinese cybersecurity hacking scandals, regulatory risks, and profit warnings. All the while, the Federal Reserve has steadily tightened monetary policy. Against this backdrop, we saw repricing among most global shares, although domestic equity posted marginally better results than international counterparts. Zeroing in on Europe, the region continues to display slowing economic momentum, a depreciating euro, and unsupportive fiscal policies. Nonetheless, perhaps in a contrarian fashion, investors hunted for value amid the selloff and placed $5.5 billion in net new flows into this relatively maligned asset class, the most since February.
Sector Investors Adopt a Defensive Posture
Earlier in the year, we saw equity weakness globally associated with tightening monetary policy and rising rates. This upward rate move pushed investors out of bond-proxy stocks typically found in Utilities and Real Estate – two rate-sensitive industries. But during October, investors moved in favor of these groups, as these classic defensive industries offer relative stability during times of uncertainty. Healthcare was another winner, as investors who still favor growth but are wary of technology valuations, are rotating to this more defensive industry. Lastly, investors fled more tariff-sensitive sectors such as Industrials and Materials, in which a few key earnings announcements showed that supply chains are destined to be disrupted by impending tariffs.
Positioning Toward Yield and Value Equities
2018 equity style performance trends have been all about growth. Yet, lately, we’ve written about increasing flows into the value factor, which has shown strength when highly priced technology shares have sold off. Investors have viewed these sell offs as an opportunity to take profits and rotate into shares that are underpriced relative to their fundamentals, hoping these value stocks can turn around their performance and help portfolios preserve the gains that have accumulated during the past decade. Thus, October saw a continuation of value’s flow momentum, as the category picked up $2.6 billion in net new flows. Another factor that has struggled is yield, which has been down significantly given the increase in borrowing costs. But recent defensive posturing has renewed interest in these high-dividend funds; investors have now placed $1.6 billion net new into the category over the past two months, the most since October and November 2017.
Record Monthly Outflow for High Yield
As rates have risen furiously this year, it has been a difficult year for all sorts of fixed income, especially anything with duration. But with the U.S. economy humming along, high-yield fixed income has been a relatively strong performer in a weak crowd, and junk bond credit spreads have largely narrowed to record tights relative to investment-grade. Yet, amid some weak performance from the energy sector, October saw this swiftly reverse, and in fact credit spreads moved to their widest levels all year. Against this backdrop, investors redeemed $4.1 billion in high-yield ETFs, a record monthly outflow for the high-yield category. This October’s “redeem high-yield” trend is not abnormal – the category has seen net outflows in six of ten 2018 months, and even a fair amount of “create-to-lend” activity, with several big high-yield funds at record high short-interest levels. Also of note, investors plowed into ultra-short duration funds to the tune of $5.8 billion, adding to record year-to-date inflows for the category at $29.5 billion. The next closest yearly total came in 2017, with only $11.1 billion in net new flows. Participants have been feverishly lowering duration exposure amid rising rates.
Eye on the Turkey
Trick-or-treat has come and gone, and the United States has seen plenty of spooky episodes, both holiday and market related. Only time will tell if this October turns out to be just a quick thriller or the start of a horror flick, but in the meantime, we’re looking to turkey and football to provide a better backdrop for markets. Specifically, capital gains season should drive retail investors to utilize the ETF vehicle even if asset class performance disappoints. As institutional investors and trend followers continue to follow performance with flows, let’s see if investors with a longer-term view can keep net flows afloat even if markets continue to spook participants.
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The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the Russell 3000 Index.
The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
The MSCI USA Cyclical Sectors Index is based on MSCI USA Index, its parent index and captures large and mid-cap segments of the US market. The index is designed to reflect the performance of the opportunity set of global cyclical companies across various GICS® sectors.
The MSCI USA Defensive Sectors Index is based on MSCI USA Index, its parent index and captures large and mid-cap segments of the US market. The index is designed to reflect the performance of the opportunity set of global defensive companies across various GICS®
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