Right on cue with the weather starting to change in the Northeast, the market’s direction changed in September. Heading into the month, roughly 70% of the firms in the S&P 500 Index were trading above their 50-day moving average. Thirty days later, only 25% of firms are above that threshold, and the broad benchmark’s relative strength measure declined every day in the last the week of month.
Compounding the negative returns in stocks, core global bonds also fell hard. In fact, after posting a 1.8% decline in September, their sixth month of losses in 2021, the year-to-date return fell to a negative 4.1%.1 If the year ended today, this would be the worst yearly decline from core global aggregate bonds since 1999.
Yet, despite the weak returns, investors’ risk-on positioning has not been severely altered.
ETFs are smashing records like punk teenagers smashing pumpkins once the sun goes down. Fund flows are already above prior-year highs, and with the fourth quarter typically representing the largest flows of any quarter ($128 billion versus $88 billion for Q4 versus Q1 to Q3 averages) the full-year figures are likely to increase. In fact, our five-factor model projection now indicates flows could reach $812 billion, or 61% higher than 2020’s record $505 billion. An uptick not unlike the increase in hearing “Happy Fall Y’all” nowadays.
These record-setting flows have been fueled by record-setting participation from all ETFs. Out of the ETFs this year that have witnessed flows (positive or negative), 67.5% have registered inflows. This marks the largest rate of participation in the past ten years.
Beyond the record-breaking flows, the trends shown below indicate both broad-based depth and persistency — a strong sign for ongoing secular adoption of ETFs within portfolios from a diverse group of investors with differing motivations.
September’s $45 billion in inflows was the lowest monthly total this year, largely due to lower-than-usual equity flows ($32 billion versus the $55 billion 2021 average). As a result, the equity to bond differential dipped to $18 billion. Yet, this figure is still well above the historical median figure and in the upper 75th percentile.
Interestingly, and speaking to the influx in more novel strategies as the ETF landscape has matured, the three non-traditional fund categories have now posted inflows over all considered time periods, as shown below. Additionally, all three have posted the largest amount of flows on a relative basis to their start-of-year assets.
Sector flows are starting to become as reliable as every craft beer company making both an Oktoberfest AND a Pumpkin Stout. The $2.4 billion of flows in September marks the 12th consecutive month of flows, a record streak that has coincided with a steroidal $92 billion of flows.
Despite the negative returns in September, intra-sector positioning did not favor defensive exposures. That group had $2.3 billion of outflows. Conversely, cyclicals had $2.9 billion of inflows. Within that group, energy ETFs had nearly $2 billion of inflows, activity coinciding with an uptick in option open interest on those sector ETFs. And the increase in option activity was led by calls (call open interest is in the 77th percentile versus put open interest sitting in the 29th percentile).
Even with the Fed starting to normalize policy and rates rising, bond fund flows continued their strong pace. The $14 billion of flows in September is the 18th consecutive month with inflows. And much like how candy corn has become the candy du jour, TIPS ETFs remain heavily favored by investors. TIPS ETFs have now had inflows of more than $1 billion for 17 consecutive months. The $3 billion deposited in September brought the three-month figure to a record $10.7 billion.
Credit/equity sensitive sub-sectors saw higher relative interest, as investors sought to tactically participate in the equity rally with bond exposures. Convertibles took in nearly $700 million (7.6% of start-of-month assets) and Bank Loan ETFs saw assets rise by 4.7% from $740 million. For the latter, this brought 2021 totals to almost $9 billion — 92% more than the prior calendar year record and greater than the flows amassed in the prior eight years COMBINED.
The market’s decline right as the weather changed combined with the ongoing risk-on buying behavior points to investors breaking out their TINA (There is No Alternative) and FOMO (Fear of Missing Out) flannel shirts. Stocks are still more attractive than bonds, based on their earnings yield versus bonds’ yield-to-worst.2 And, as we have seen throughout history, whether it is the “buy the dip,” “stocks only go up,” or “stocks for the long run” crowd, drawdowns have served as buying opportunities for many.
The debt ceiling debate could change all of this, however, just as an early snowstorm disrupts the serene fall skyline, forcing everyone to protect their well-crafted pumpkin displays from being destroyed. I’d expect the same trend from prior debt ceiling fights to occur this time as well, however. A few days of tension as we white-knuckle it a bit, before a resolution is ultimately reached.
Debt ceiling aside, there are significant questions to how the last three months of the year will play out. I covered the two biggest ones (rally concerns and real income needs) in recent blog posts. I discussed how a blend of quality and value may help navigate the lack in style leadership and still-elevated valuations and how floating-rate credit may be able to provide income levels above the rate of inflation, while mitigating impacts from the likely rise in rates.
In the end, markets change just as a frequently as the seasons do. Yet, investors’ consistent buying behavior indicates they are looking through the most recent fall.
1 Bloomberg Finance, L.P. as of September 30, 2021 based on the return of the Bloomberg Global Aggregate Bond Index.
2 The MSCI ACWI Index earnings yield is 4.5% compared to the Bloomberg Global Aggregate Bond Index yield to worst of 1.17%, Bloomberg Finance L.P. as of September 30, 2021.
Bloomberg Global Aggregate Bond Index
A broad-based flagship benchmark that measures the investment grade, global fixed-rate taxable bond market.
MSCI ACWI Index
A market-capitalization-weighted stock market index that measures the stock performance of the companies in developed and emerging markets.
S&P 500® Index
A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.
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