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Flash Flows

Sentiment Surprises to the Upside

Risk assets rallied in October after months of negative returns. Stocks posted their best October return since 2015 and high yield bonds rallied 3% as spreads tightened. Buoyed by $60 billion of inflows into equity ETFs, total flows surpassed $90 billion in October. Meanwhile, bond flows were their fifth-most ever (+$27 billion), fueled by a resurgence in high yield flows (+$7 billion, second-most ever).

Head of SPDR Americas Research

October is full of surprises. A World Series pretender turns into a contender. Kids try their best Michael Myers impressions on unsuspecting adults. And of course, Instagram like-inducing posts of fall foliage mean hours of blister-producing raking that your instafriends never see.

This October doled out a fresh surprise to investors. Risk assets rallied after months of Federal Reserve rate hike fueled negativity. Global equities posted their best October return since 2015 and their best overall monthly return since this past July.1

This rally was a welcome sight. Yet, is this rally more like the sixth grader dressed in the Guy Fawkes costume ready to egg your house the minute you shut off the front light at 8 PM (i.e., the tricker) or the sweet second grader living her best Elsa life asking for just one more Kit-Kat (i.e., the treater)?

Signs point to this rally being slightly more durable than the one in July, as heavily shorted stocks (i.e., a short cover rally) didn’t bounce higher in October. Another indicator is the buying behavior this time around.

Back in July, ETFs had only $35 billion of inflows. In October, however, sentiment surprised to the upside with ETFs taking in $90 billion. Yet, not all areas thrived.

Big Flows, But Still Sub-par Depth

Following months of below-average flows, ETFs surprised to the upside in October with $90 billion of inflows. Equity flows drove the topline figures, taking in $64 billion in October. Funds focused on the US were the primary allocation, taking in $55 billion.

For all ETFs, this is the sixth-most flows ever for ETFs and pushed total flows to over $500 billion for the year. In fact, as shown below, the flows in 2022 are now the second-most ever — surpassing the prior second place record of $503 billion in 2020. This is also now the third consecutive year with flows over $500 billion.

So far in 2022, even with the significant volatility, flows averaged $48 billion a month. Historically, November and December have averaged a combined $120 billion of inflows. Apply these two averages into an ensemble forecast, and ETFs could conceivably witness inflows of $110 billion over the next two months. This would put forecasted full-year flows at $620 billion.

Flows go over $500 billion for the year

Rolling Three-month Equity Minus Bond ETF Flows

While the notional total flow figures for October were impressive, the beneath-the-surface trends were not overly robust. Similar to prior months of below median participation, only 54% of funds had inflows (versus a historical 63% rate).

The lack of depth extended across all major categories, as not one segment was above its historical median. And in the prior five instances when flows were over $90 billion in a single month, the participation rate averaged 67%. Overall, the below median participation rate supports the trepidation toward the vibrancy of the headline buying behavior.

Sectors Strike Back with Inflows While Dividends Remain in Style

Following their worst month of outflows ever in September (-$9.9 billion), sector funds rebounded in October with their ninth-best month ever – taking in $7.6 billion. This pushed full-year sector flows positive once again. Nine out of the 11 sectors had inflows in October, a reversal of the year-long trend as only five sectors have net inflows year-to-date. The flows and depth are a good sign of risk-taking.

Technology led all sectors in October with $3 billion of inflows while cyclicals (+$3.3 billion) outpaced defensives (+$600 million). Yet, the latter, led by $1.4 billion into Health Care, posted a record 12th consecutive month of inflows — underscoring the preference for defense in 2022.

Sector Flows

Sector Flows

Value funds surpassed growth exposures for the third straight month, taking in $11.6 billion in October – their sixth-largest inflow ever. This pushed full-year value flows to $94 billion, a new annual flow record. With growth flows at just $17 billion, the differential between the two styles is at its widest ever ($77 billion) for a calendar year. Given the strong performance of value over growth last month (+5%) and year to date (+25%), these flow trends are not a surprise.2

Out of the $11.6 billion into value, $3.5 billion came from inflows into dividend funds, as they fall into the traditional value category. October was dividend funds’ 27th month in a row with inflows, three months shy of their record streak.

Dividend funds year-to-date total is now over $60 billion. This is the most ever for a calendar year, with two months left to go. These flows have also helped propel Smart Beta funds to a record annual flow total.

Hungry for High-Yield Bonds Amid Rally

High yield also had positive returns in October, rallying by 3% as spreads tightened by 88 basis points (bps) on the month.3 The strong rally brought buyers back, as high yield ETFs posted their second- most flows ever (+$7 billion).

This was also just their third month of inflows this year, a significant sign of a reversal. Total 2022 flows for high yield exposures remain in net outflows (-$8 billion), however. Yet, they are no longer the worst ever, as they are now just narrowly better than the -$9.5 billion from 2019.

Given that spreads have compressed so quickly — 36 of the 88 bps decline came in the last week and spreads are now 10% below their long-term average — a repeat of the robust buying behavior next month may be hard to come by.4

The $27 billion into bond funds in October was fueled by other segments as well, as nine out of 11 bond sectors had inflows last month. This is a departure from the year-to-date trend, as only four sectors have net inflows in 2022. Despite the low depth this year, bond flows are already at their third-most ever for a year (+$153 billion). Yet, they are unlikely to break $200 billion for the third straight year, unless there is repeat of October’s performance in each of the next two months.

Fixed Income Sector Flows

Geography Flows

Will the Surprise Continue?

The foundations remain somewhat uncertain. Earnings sentiment continues to wane as revisions push full-year 2022 and 2023 estimates lower.5 Economic data are sluggish and geopolitical tensions remain high. And 2022 is forecasted to be the Federal Reserve’s most aggressive calendar year ever.6

Of course, surprises are usually fleeting. Therefore, like the angst-provoking Halloween calculation that each kid will “just take one,” investors should be filled with a bit of trepidation heading into the final months of the year.

Leaning into what has worked so far this year — high quality/value and ultra-short bonds — may mitigate the pain of any October surprise reversal and help you get portfolios to 2023.

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