Many are referring to 2022 as the “trilogy” year, as it is now the third calendar year in which the world has had to deal with the pandemic. And for our collective wellbeing, I hope they are right, as the third movie or “act” in a trilogy usually signifies the end, after the first two acts set the stage and introduce the protagonists and antagonists.
For instance, in the first Star Wars (well really, the fourth), an emerging threat to society is revealed (Darth Vader and his Death Star). Toward the end of the first act, our protagonist (Luke Skywalker) realizes his abilities with the “force,” offering hope for the future (after all, Star Wars Episode IV is titled A New Hope). This timeline eerily follows the events that took place in 2020.
COVID-19 fully arrived in the spring of 2020, creating sizable disruptions throughout our society that will be felt for generations to come. Yet, by the fall there was some hope for an end, as the vaccine timeline was announced and individuals across the globe started to receive their shots.
By episode VI (Return of the Jedi) the dark forces have been defeated and our protagonists emerge victorious. Every Star Wars trilogy (the original, prequel, and sequel) followed this pattern.
The hope for us is that this pandemic trilogy has the same arc. ETF flows so far definitely point to investors positioning in a decidedly risk-on manner and that this trilogy will not turn into a saga.
Record Flows Supported by Equities
US-listed ETFs took in $119 billion in December, a record amount that exceeded the prior record of +$98.7 billion in March 2021. It is also the first time flows surpassed the $100 billion mark for a month.
More impressive, December flows pushed the already record-setting annual figure to easily break through the noteworthy barrier of $900 billion (+$908 billion). The record-setting flows in December were fueled by record-setting equity flows (+$95 billion), which were supported by record-setting US equity exposure flows (+$76 billion).
With such strong equity flows, positioning was definitely risk-on. This is a trend more evident when comparing equity to bond flows over the last three months. As shown below, over the past three months, equity funds have outpaced fixed income strategies by $153 billion. This is the third-most all-time and is in the 98th percentile historically.
Trailing Three-Month Equity Minus Bond ETF Flows ($ Billions)
Equity Flow Depth at the Regional and Sector Level
The US was not the only segment to post records in December. International developed focused equity strategies took in a record $14 billion last month, pushing their full-year figures to a record $96 billion. This flow strength was felt beyond the two largest geographical regions, as all major geographic segments we track posted inflows not only in December, but also for all of 2021.
The equity fund flows were further supported by sector strategies, as they took in $85 billion, with $8 billion of inflows last month (10th most all-time). With the inflows in December, sector-focused ETFs now have had inflows in every month in 2021, their first year with inflows in every month of a calendar year.
At the intra-sector level, US cyclical sectors were once again favored (+$4.4 billion) in December – as they had been all year. Yet, US defensives did take in $3 billion last month. However, that did little to dent the full-year trend of investors seeking out more cyclical exposures, as for the year, cyclicals outpaced defensives $48.7 billion to $4.9 billion. Financials, Energy, and Real Estate led cyclical flows in December and for all of 2021, and were three out of the top four sector asset gatherers this year.
Fixed Income Flows Support Growing Tactical and Strategic Usage of ETFs in Portfolios
Fixed income ETFs took in $25 billion in December, their sixth-most ever, and were mainly driven by opposing forces.
Government funds led with nearly $8 billion, featuring seemingly equal positioning across the maturity spectrum. The next largest sector with inflows was Aggregate funds. Taken together, some of the positioning in bonds appears risk-off, partially counterbalancing the risk-on sentiment expressed in equities.
Despite the strong flows into the defensive bond segments, high yield funds posted their sixth-most inflows ever with $4.2 billion. And bank loan funds were able to keep their streak alive, registering inflows for 15 consecutive months. Add in over $1 billion into IG Corporates, nearly $1 billion into EM Bonds, and $500 million into Preferreds, and the bond positioning looks less risk-off than when viewing it through the Government and Aggregate lenses.
Overall, given that only two segments had outflows in December, and none had outflows on the year, the strong flows represent increased usage. And it appears portfolios were both being positioned for yield and stability, with ongoing inflation protection heading into 2022.
Fixed Income Sector Flows
May the Force Be With Us
The foundations are there for this third year to resemble many third acts. Policies as well as growth are supportive, and health efforts are improving. Yet, there is still a lot of uncertainty around the virus. However, amid many unknowns, there are a few things we do know:
Omicron is less severe than other strains, particularly for the vaccinated1
The surge in cases is shorter for omicron than for previous variants,2 and there has been a greater emphasis on test-to-stay stay versus shut down3
Omicron has turned on delta (like Vader did on the Emperor), making a delta infection less likely following omicron4
Access to testing continues to expand,5 even though it can still be improved, which can help prevent spreads
Perhaps it’s the optimist in me, but those factors make me hopeful that the COVID trilogy will go the way so many have in the past, and that what we witness in 2022 is the continued rebuilding of our economy brought on by increased vaccination rates and fewer case surges that have upended lives and overall sentiment.
The pandemic might not end fully in 2022, but the threat could be far, far weaker as more health progress is made. After all, even the Evil Empire morphed into the First Order by the time The Force Awakens rolled around –a weaker version of the first rendition that was easily dismantled by new protagonists.
Therefore, from a positioning perspective, consider remaining overweight risk assets, like stocks, high yield bonds, and bank loans. And may the force be with us in 2022.
1 “New Studies Point to Omicron Being Less Severe”, Bloomberg December 22, 2021. 2 “South Africa’s huge omicron wave appears to be subsiding just as quickly as it grew”, the Washington Post December 22, 2021. 3 “Biden administration unveils push for 'test-to-stay' policy to keep kids in school”, NBC News December 17, 2021. 4 “Omicron Variant Might Help Defend Against Delta, Lab Study Suggests”, The New York Times December 28, 2021. 5 “Biden administration announces $137M deal to boost production of key Covid test component”, NBC News December 30, 2021.
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