A combination of encouraging health-related news and sizeable stimulus measures around the world sent risk assets bouncing back in April. Global equities finished up 11%—their best monthly return since 2011—and investment grade (IG) corporate credit ended the month just 3% below pre-pandemic crisis levels, regaining nearly all of its 21% March drawdown.
Every major asset class category had inflows in April, as investors broadly allocated capital so as not to miss out on any bounce-back gains. Even the losers—stock market segments that had been underperforming year to date through April 24—popped up in the last week of the month, pushing the rally even further.
The market exuberance is in sharp contrast to negative economic and corporate news, including forecasts of US second-quarter gross domestic product (GDP) declining a staggering 26% quarter over quarter1 and corporate profits coming in negative every quarter this year.2 This disconnect begs the question: “Is this rally real?”
Geographic ETF flows: US equity funds posted inflows, while non-US ETFs saw another month of outflows
Geographic equity flows reveal that sentiment was uneven in April. US ETFs had $19 billion of inflows, while non-US ETFs saw $10 billion of outflows, posting outflows for a second consecutive month. See the table below. Emerging market (EM) and developed market exposures led the non-US outflows, with EM equity ETFs marking their third consecutive month of outflows. Year to date the EM segment is down by almost $8 billion in flows, equating to a loss of nearly 4% off of its start-of-year assets. Currency hedged ETFs saw a larger relative decline, losing 13% from their start-of-year assets, while regional funds finished the month down almost 8%.
The time-series chart below illustrates the dispersion in sentiment by breaking out the equity flow patterns into US ETFs versus non-US ETFs. It depicts how investors in the most recent three-month period fled non-US equity ETF exposures at the fastest rate tracked, redeeming more than $19 billion from non-US equity-focused ETFs. Meanwhile, investors deposited $57 billion into US-targeted strategies, leading to a differential between US and non-US exposures of nearly $80 billion. That marks the fourth-largest differential over the time period measured and the only one of the top-four differentials with non-US outflows and not just rampant US inflows. These flow patterns illustrate investors’ clear preference last month for expressing a risk-on view via US exposures rather than via exposures to non-US markets, where economic fundamentals may not be as strong as they are in the US.
Sector ETF flows: Sector ETFs amassed nearly $15 billion in April, their third-largest monthly inflow total
Sector flows rebounded to near-record levels in April. As evident in the table below, sector ETFs amassed nearly $15 billion of inflows, their third most monthly inflows. April’s $15 billion is just $1 billion below the number two spot recorded in 2014, and $3 billion below the top haul, which occurred following the 2016 election. It’s also more than the last 34 months of sector flows combined.
The sheer magnitude, depth (the number of sectors with all-time inflows), and breadth (the number of sectors with inflows) of April sector flows indicates investors’ targeted bullishness. Three sectors registered their largest monthly flow total ever last month: Technology, Health Care, and Materials. This is the highest number of sectors experiencing record monthly inflows together. Additionally, up until the last day of the month, every sector had inflows for the month—a feat not seen since 2005.
In contrast to the top two months for sector inflows, April’s sector flows were evenly split between cyclicals and defensives—with a bias toward defensives, given the flows into Health Care. See the chart below. These strong inflows, combined with declining levels of short interest, indicate that investors were buying the April rally and expressing their views by specifically targeting segments of the US economy, rather than simply buying broad beta. Investors focused particularly on those areas that have shown strong earnings sentiment, namely Tech & Health Care.
The Health Care sector posted record monthly inflows last month, enabling its rolling three-month flows to massively rebound from where they were during the onset of the Democratic primaries when political risks curtailed sentiment toward the sector. See the chart below. Health Care ETF flows are now in the 90th percentile, with the potential to remain elevated given supportive macro (COVID-19 treatments and vaccines) and micro (earnings sentiment) trends.
Fixed income ETF flows: Bond ETFs rebounded in April from their worst month of outflows
Bond ETFs rebounded in April from their worst month of outflows, posting $22 billion of inflows—their second highest monthly total and a figure well above their recent monthly median level. March had marked bond ETFs’ first month of outflows in 16 months and their worst month on record. Bond ETF flows in April returned to the strong upward trend they had been on before the pandemic-led volatility started. See the far right of the chart below.
Flows were led by seemingly bifurcated sectors in terms of risk. Government and Aggregate funds—interest-rate driven and to an extent defensive exposures—took in a combined $9 billion, as investors expressed uneasiness about the persistency of the April rally. Meanwhile, the risk-on credit sensitive segments of high yield and investment grade corporate credit amassed a combined $14 billion. They benefited from a positive turn in investor sentiment following the Federal Reserve’s announcement, and subsequent expansion, of various programs to support the market and seemingly backstop any risk taking.
The more than $6 billion deposited into IG bond ETFs is a monthly record, as is the $7 billion for high yield. April inflows for these two segments combined were a record, as shown below. Spreads for both segments are well above averages, despite weak corporate fundamentals.
Strategy ETFs: Active ETFs rebounded, while smart beta strategies weren’t as lucky and ESG inflows were shallow
Active ETFs rebounded with inflows in April, after witnessing outflows for only the third time in 60 months in March. Smart beta strategies were not as lucky, however. With many factors in net outflows, the entire segment was in net outflows for the second consecutive month, its first period of back-to-back outflows since 2015. ESG funds continued to take in assets. However, the depth of ESG inflows was shallow, as 89% of April inflows were into four funds, and 71% of the 2020 flows were from two funds. This concentration means it’s too early to say if the rising tide of ESG is lifting all ESG boats.
Is this rally real?
For a full recovery and a sustainable rally to occur, we need a real health solution—addressing treatment, tracing, testing, and vaccines—that ensures novel viruses like COVID-19 can be mitigated in the future. This would enable consumers to regain the confidence to leave their homes and return to fueling the real economy. We also need ongoing monetary stimulus to increase business activity and lending, as well as expanded fiscal stimulus to bridge the gap for many small businesses and consumers.
Until this troika is in place, investors should expect more volatility. Double-digit gains amid a pandemic are unlikely to be the norm, as we get deeper into the second quarter. We will then start to see economic data released that covers the entirety of lockdowns, as more states begin to reopen. We will also see progress to stem the pandemic unfold in real time—with potentially good, and not-so-good, news.
Overlaying a defensive-quality bias into portfolios to maintain market exposure, while also seeking to mitigate both macro and fundamental volatility may offer opportunity. We also could see potential in segments of the market—such as Heath Care and Technology—with positive growth trends and high margin, or non-cyclical, business models that offer products and services in demand during this pandemic.
Stay current on what State Street Global Advisors is seeing in ETF flows.
1 Based on consensus analyst estimates per Bloomberg Finance L.P. as of 04/30/2020. 2 Based on consensus analyst estimates per FactSet as of 04/30/2020.
Beta Measures the volatility of a security or portfolio in relation to the market, usually as measured by the S&P 500® Index. A beta of 1 indicates the security will move with the market. A beta of 1.3 means the security is expected to be 30% more volatile than the market, while a beta of 0.8 means the security is expected to be 20% less volatile than the market.
Credit Spread The difference in yield between two bonds of similar maturity but different credit quality.
Short Interest The amount of shares that have been sold short but have not yet been closed out or covered.
Smart Beta A term for rules-based investment strategies that don’t use conventional market-cap weightings.
ESG An investing style focused on environmental, social, and governance information.
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