After coronavirus-led growth concerns paused the markets’ momentum in mid-January, global equities declined 3.8% over the last two weeks of the month. January marked the first monthly fall for global equities since August 2019.
Now, growth expectations are being reset and risk assets (i.e., stocks) are being repriced—but that’s it. The rally has been paused, not stopped. The recent downturn is all about a scare that impacts the consumer—the largest part of our global economy and the one pillar bearing the majority of the load after trade tensions created fissures in manufacturing.
Asset class exchange traded funds flows: Equity and bond flows were seasonally strong, but investors showed signs of de-risking
With global equities registering seven new all-time highs to start off January,1 investor sentiment was considerably positive prior to the late-month sell-off. As a result, flows were stronger than normal into equities. Historically, January is one of the weaker months in terms of fund flows, averaging only $3 billion over the last 20 years. The $20.6 billion amassed by equity ETFs in January 2020 is roughly six times greater than that 20-year average.
Bond flows also posted a record, running three times greater than their 20-year January average. With equity volatility increasing, flows into bond funds accelerated as investors sought to de-risk, depositing $4 billion over the last five days of the month alone.
High-yield ETFs, which correlate strongly with equities and had credit spreads at expensive levels given that they were more than 30% below long-term averages,2 posted $777 million of outflows last month. Investors primarily favored interest rate-sensitive segments, such as Government and Aggregate exposures. Mortgage-backed ETFs took in $3 billion of inflows, representing a 9% increase in start-of-year assets—the most for any bond segment.
Since mortgages yield roughly 10% more than the broader Bloomberg Barclays US Aggregate Bond Index but with 40% less duration3 and limited credit risk, investors may continue seeking out this underexposed segment (based on asset size relative to other ETF bond sector categories) to balance yield and risk levels.
Geographic ETF flows: Investors favored large markets, but their intentions in China are unclear
Global, regional and currency-hedged ETF strategies lagged in January, with investors primarily favoring larger discrete segments of the equity market. U.S. exposures took in over $10 billion, while international-developed amassed $7 billion, taking in the most flows as a percentage of their start-of-month assets (+1.7%). With softened trade tensions driving interest during the early part of the month, emerging markets took in $2.2 billion, or1.1% of their start-of-month asset base—the third-highest relative percentage in the geographic category. However, as the coronavirus outbreak impaired sentiment toward the region in the last weeks of the month, emerging market ETFs lost $1.5 billion, or 0.8% of their assets in the last five days.
The same trend held for single-country exposures, the segment with the second highest relative flow percentage figure for January, at 1.5%. Almost $500 million left those strategies in the last five days of the month. Despite those outflows, single-country funds still took in more than $1 billion in January for the fourth month in a row. However, the devil may be in the details, as the inflows were dominated by China-focused ETFs, which took in $1.6 billion. It’s possible this dynamic represented savvy traders attempting to short the ETF prior to the Lunar New Year holiday. Short interest information becomes known 15 days in arrears, so we will have to wait to find out.
Sector ETF flows: Market volatility produced mixed results
From a sector perspective, January was a tale of two halves. At one point during the first half of the month, more than $8 billion had flowed into sector-related strategies—a January record. However, once growth fears stemming from the coronavirus took hold, the first of what would ultimately become $3 billion in outflows began.
More cyclical segments, such as Industrials, Materials and Financials, benefited early in the month on lower trade tensions, higher bond yields and expectations of strong growth. In the last week of the month, however, investors redeemed $2 billion across those three segments, offsetting some of early January’s gains.
The month ended mixed across sectors, with Technology and Consumer Discretionary segments taking in the most assets, despite their sizable overseas footprints. This positivity likely stems from the strong earnings reports produced in those sectors to date.4
The positive sentiment from earnings has not extended to Health Care. Despite 89% of Health Care firms surprising on revenue,5 investors are still shunning the politically charged sector.
Markets hit the pause button in January, not the reset button
Despite the recent price action, the market’s outlook is not that bleak. After all, this is a pause, not a stop. As it did during other outbreaks (SARS, Ebola), the market will readjust to the new paradigm. But here is the deal: The structural reasons why the market fell remain. Stocks will fall again if the already slow growth comes under new pressure.
Earnings are mixed, valuations are not cheap, and policymakers offer support to keep the game going but are not able to solve the larger growth problem by fostering organic growth. In a market like this one, focus on strategies that offer upside potential but limit downside risk.
Stay current on what State Street Global Advisors is seeing in ETF flows.
1 Source: Bloomberg Finance L.P. as of 01/31/2020 based on the MSCI ACWI IMI Index.
2 Source: Bloomberg Finance L.P. as of 01/31/2020 based on the Bloomberg Barclays US High Yield Corporate Bond Index.
3 Source: Bloomberg Finance L.P. as of 01/31/2020 based on the Bloomberg Barclays US MBS Index.
4 Source: FactSet as of 01/31/2020.
5 Source: FactSet as of 01/31/2020.
Bloomberg Barclays US Aggregate Bond Index:
A flagship measure of investment grade debt issued in US dollars. The benchmark includes Treasury, government-related, corporate, and securitized fixed-rate bonds.
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