I recently participated in the first-ever virtual March for the Fallen, an event honoring armed service members who have sacrificed their lives in combat for our freedoms and the Gold Star families that keep their memories alive. Knowing I would be facing a long, challenging Boston course, I began training several months ago. I planned to run as much of the route as could. My strategy was to identify landmarks to reach on the course, where I would then evaluate my stamina and pain to see how much further I would run. My mantra was, “Just get to XYZ point.” For me, it was a course comprised of five-mile increments.
I ultimately ran 27 out of the 31 miles—a personal best—and surprised myself along the way. While I was on the course, trying to get to my next checkpoint, the process of running that long distance felt much like trying to navigate this market.
At one point, I was starting to fade and knew I was two miles from my mile 14 checkpoint, where I planned to stop for a quick walk. Right then, a perfect song came on my playlist, giving me enough of a boost that I ran my third fastest mile split—right as I was about to enter the pit of despair and give up.
In terms of the market, my endorphin-pumping adrenaline shot of music was much like the Federal Reserve and Congress pumping trillions into the system at the onset of the pandemic, seeking to offset the pain the economy was feeling as a result of the humanitarian crisis and shutdowns. Like the stimulus, my music didn’t get rid of the pain but only masked it.
Later, I faced a water crisis: The course didn’t feature any fancy water tables with Gatorade or pickle juice. It was “BYOW” and I brought one less water than I needed. This is no different than the market no longer having access to fresh fiscal stimulus. The market is now paying the price of not being able to hit up the water table and grab a cup of fresh stimulus—and it still has some distance to cover before the pandemic is over. It needs one more round than it has been given, one of the reasons why the market became more volatile in September.
The course featured a few hills, which can break a runner’s spirit. The best way to get past hills is to train for them. Same with market volatility, to a degree. In this scenario, training equals diversification. Since 1979, the standard sixty-forty portfolio of S&P 500® Index stocks and aggregate core bonds provided 91% of the return of stocks but with 64% less volatility and 36% lesser max drawdowns.1 In 2020, the sixty-forty portfolio has earned more than 100% of stocks returns with 40% less volatility.2
Asset class ETF flows: Fixed income, gold funds still running hard
Despite the market volatility, equity ETFs still took in $20 billion in September, upping their year-to-date total to more than $100 billion and pushing total assets past $3.5 trillion. Fixed income ETFs continued their record-setting pace, adding $13 billion in September to bring the 2020 year-to-date figure within $600 million of the 2019 annual record.
The equity flows reflect modest positioning within some of the more tactical market tools, as one might expect with such a volatile market and the ability to leverage the flexibility of the ETF structure to go either long, short, or obtain exposures through derivatives. Because of these investor use cases and the record-setting figures for trading volume, short interest and ETF options volumes, I recently proclaimed 2020 as the best year ever for ETFs—even if overall industry flow totals don’t break records.
Flows into commodity funds continue to shine, led by precious metal exposures, such as gold. In fact, with gold funds taking in more than $2 billion, September marks the ninth consecutive month with flows greater than $1 billion and the eighth month in a row of flows greater than $2 billion—all record figures and the reason why the $34 billion haul in 2020 is also an annual record.
Gold flows have been persistently strong in 2020, given the high risk/low real rate regime fueled by the global pandemic. With no likely abatement in macro risk flashpoints—thanks to the US election and the under-the-radar kerfuffle that is still Brexit—demand for defensive, risk-off assets like gold may persist. As a result, the probability of having more than $1 billion of flows every month in 2020 is within the realm of possibility.
Sector-focused equity ETF flows: Hitting a wall
Sector-focused equity ETFs lost more $4 billion in September, within $1 billion of the outflow amount seen at the onset of the pandemic in March ($5.3 billion). Overall, nine of the eleven sectors had outflows in September, led by Financials and Technology. The latter sector had not had outflows of this magnitude in 14 months, emblematic of the nature of the September sell-off which saw technology stocks sink 5.4%.3
De-risking ensued as a troika of fears spooked investors:
Rising COVID-19 case rates ahead of colder months in many parts of the world
Lack of movement on stimulus measures from Congress
Paying elevated prices for next year’s earnings after a parabolic rally pushed the S&P 500 Index into extremely overbought territory, as evidenced by an RSI north of 80.
Only two sectors had inflows: Industrials and Materials, both segments that could be considered part of the re-opening trade, given their sensitivity to economic activity. However, the bullish optimism evidenced by these flows may be curtailed, as the two sectors also saw a rise in short interest on the month. As a result, a portion of these inflows could be from investors that are skeptical of the path ahead.
Thematic ETF flows: Long-distance runners
Funds focused on emerging trends in our economy took in $2.1 billion last month, raising the year-to-date total for these NextGen Trends funds to nearly $18 billion. This represents a 46% organic growth rate in assets under management outside of any price appreciation from strong fund performance. Two-thirds of these funds are beating the S&P 500 Index this year, with an average return of 22%.4 Flows were once again led by funds targeting broad-based innovation.
While thematic and secular are opposite terms, these thematic ETFs represent exposures that capture secular change. Our daily routines have decidedly shifted. The world we knew in January is not the one we find now, and investors have sought to add exposures that offer access to the innovative firms at the forefront of our society’s transcendent change. The long-term nature of the systemic societal sea change and the potential these firms offer for future growth may underpin both flow and price momentum.
Government bond ETF flows: Taking a risk-off lap
Government bond ETFs saw inflows across all tenors, with the most inflows centered on the longer end of the maturity curve. The flows into long-term bonds brought the year-to-date flows for the segment into positive territory for 2020.
With equity markets trading below technical indicators (the S&P 500 Index broke through its 50-day moving average and touched the 100-day within September), investors sought out defense and once again gravitated towards the comfort of US Treasuries—even if they yield almost 0%. If the market continues to be volatile, look for investors to take more risk-off laps, with government bond ETFs and gold potentially benefiting with more inflows.
Navigating the steep hill ahead
The next hill the market needs to climb on this long, strange journey is the US presidential election. Investors should adopt a runner’s mindset here: Just try to get past it without doing harm. Diversification will be key as investors climb this hill of potential volatility. Past courses could provide some insight, considering the likelihood the election results could be delayed as they were in 2000. Back that on that 2000-era hill, defensive exposures like gold, long-term Treasury securities, high quality stocks, and low volatility strategies mitigated the market’s tumultuous terrain. The same may apply in 2020 as the market just tries to get past November 3rd.
1Bloomberg Finance L.P. as of 8/30/2020 based on calculations by SPDR Americas Research 2Bloomberg Finance L.P. as of 9/30/2020 based on calculations by SPDR Americas Research 3Bloomberg Finance L.P., State Street Global Advisors, as of September 30, 2020 4Bloomberg Finance L.P. as of 9/30/2020 based on calculations by SPDR Americas Research
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