Living in New England you get to live through all four seasons. And right now we are going through a bit of a cold snap — not unlike what markets and portfolios are experiencing right now. While capital markets haven’t had to figure out where to put two feet of snow so that it doesn’t end up in the street, there have been similar frustrations.
Broad-based volatility has increased across a variety of macro sectors. Stock, rate, and credit volatility are all trading in the top 85th percentile over the past five years.1 And the positivity from 2021 has not carried over into 2022 for either capital market returns or fund flows. For the former, the standard 60/40 portfolio posted its worst monthly return (-3.2%) since March 2020,2 a figure that ranks in the bottom 9th percentile historically.3
Flows have followed a similar, albeit less dire trend with only a few bright spots beneath the surface.
Lowest Flows Since March 2020
In 2021, ETFs averaged $75 billion a month. Thirty-one days into the new year, ETFs have posted less than $20 billion of inflows — their lowest monthly total since March 2020 and 73% below their record-breaking 2021 monthly average.
Some of the weakness is from typical seasonality effects, as January flows, on average, are the second lowest of any other month and have the highest percentage of periods with outflows. As shown below, the weak January flows are usually a reversal of strong November and December flows, speaking to some of the tax-related seasonality. The other driver of weak flows, however, was lackluster bond flows. Bond ETFs posted outflows for the first time since March 2020.
Historical Monthly Flows
Equities a Meager Bright Spot
Even though overall flow trends were suppressed, there were still areas of positivity. Six out of the seven geographical segments had inflows, led by international-developed exposures taking in over $10 billion on the month. This was their fifth most ever, continuing their record run of 20 consecutive months with inflows. And EM funds have now had inflows for 16 consecutive months, one month shy of their historical record.
Single-country funds also had inflows last month (+$3.9 billion) but were once again led by China-related ETFs. The latter had $3 billion of inflows, the most flows into China ETFs ever for a month.
The US was the only segment to have outflows. However, that was largely driven by two factors: one sentiment based (large outflows in growth) and the other a calendar event (seasonality trends in large-cap exposures).
Sectors: The Brightest Bright Spot
The $15 billion into sector funds was their fourth most ever and continues a record streak of 16 consecutive months of inflows. Over that time period, sector funds have amassed $123 billion, far greater than other presumed tactical instrument (single-country, smart beta, and thematic ETFs).
With sector dispersion elevated across all time periods (1-month = 97th percentile, 3-month = 74th percentile, and 6-month = 83rd percentile),4 the increased usage of sector strategies to make specific allocations based on prevailing macro or fundamental data is likely to continue.
The flows in January were led by cyclicals, namely Energy and Financials. The latter took in over $5 billion, while the former amassed nearly $3 billion of inflows.
While cyclicals led, there was depth associated with the sector flows. Defensives, led by Heath Care and Consumer Staples, took in over $6 billion. And only three sectors had outflows on the month as well (Industrials, Consumer Discretionary and Communication Services), whereas typically six, on average, have outflows.
Loans Only Bright Spot in Fixed Income
While high yield flows (-$7 billion) made up more than 100% of the overall outflows (-$7 billion), there was still weakness among the entire cohort, as eight out of 11 bond sectors where we parse flows had outflows in January.
That level of weak breadth is also the worst since March 2020. In fact, in the past five years, there have only ever been three instances where more than eight sectors had outflows in a month (January 2022, March 2020, and October 2018 when the Fed was raising rates aggressively). On average, only three bond sectors have outflows in a month.
Senior loan ETFs were one of the few bright spots in bonds, as they had inflows for their 16th consecutive month, pushing overall assets under management to nearly $20 billion. This month’s allocation was partly a rates play as senior loans have floating-rate coupons, but also a relative value trade considering loans outperformed fixed-rate high yield by 3%5 — a figure that sits in the 95th percentile, historically.6
Fixed Income Sector Flows
Ready for a Thaw
Taken all together, the through line of the most recent volatility is that the inputs to any cash flow model have changed. Rates are higher, pushing valuations lower. Earnings are weaker, making future cash flows being valued further out on the horizon just less to begin with. And the noise, or error term, reserved for randomness is less predictable given the macro risks.
So where to from here? Well, like most cold snaps in the Northeast, they thaw. And the markets will, too. The price action in January was a re-rating. Nothing more.
It is not a harbinger of oncoming doom or economic calamity, the latter statement supported by the fact that the latest US GDP data surprised to the upside.7 Remember, stocks had gone three years in a row with double digit gains, with no drawdown greater than 5% in 2021 alone.8 Like going all of December and January without a big storm, the markets were simply due for some volatility.
For positioning amid the cold snap, and potentially beyond as the factors above are not transitory, we still favor the themes outlined in our outlook: quality and value in the core for equities, and utilizing actively managed senior loans as a floating-rate high-income credit solution in bond portfolios.
1Bloomberg Finance L.P., as of January 31, 2022 per calculations by SPDR Americas Research, based on the CBOE VIX Index, CBOE MOVE Index and implied volatility of three-month 100% moneyness options on high yield and investment grade corporate bond ETFs. 2Bloomberg Finance L.P., as of January 31, 2022 per calculations by SPDR Americas Research based on a monthly rebalanced portfolio of 60% allocated to the MSCI ACWI Index and 40% to the Bloomberg US Aggregate Bond Index from January 1988 to January 2022. 3Bloomberg Finance L.P., as of January 31, 2022 per calculations by SPDR Americas Research based on a monthly rebalanced portfolio of 60% allocated to the MSCI ACWI Index and 40% to the Bloomberg US Aggregate Bond Index from January 1988 to January 2022. 4Bloomberg Finance L.P., as of January 31, 2022 per calculations by SPDR Americas Research based on the returns of the eleven S&P 500 GICS Sectors. 5Bloomberg Finance L.P. as of January 31, 2022 per calculations by SPDR Americas Research based on the returns of S&P/LSTA Leverage Loan Index ad the ICE BoFA US High Yield Index from 1995 to 2022. 6Bloomberg Finance L.P. as of January 31, 2022 per calculations by SPDR Americas Research based on the returns of S&P/LSTA Leverage Loan Index ad the ICE BoFA US High Yield Index from 1995 to 2022. 7“U.S. Economic Growth Quickened Last Quarter with Inventory Boost”, Bloomberg January 27, 2022.
8Bloomberg Finance L.P., as of January 31, 2022 per calculations by SPDR Americas Research, based on the daily returns of the S&P 500 Index.
Bloomberg US Aggregate Bond Index
A flagship measure of US investment grade debt from twenty-four local currency markets. This benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds.
Difference between returns across assets.
Global Industry Classification Standard (GICS) is a method for assigning companies to a specific economic sector and industry group that best defines its business operations.
Characterized by higher price levels relative to fundamentals, such as earnings.
ICE BofA US High Yield Index
The ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
MSCI ACWI Index
A market-capitalization-weighted stock market index that measures the stock performance of the companies in developed and emerging markets.
Characterized by firms with strong balance sheets and high profitablity .
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.
S&P/LSTA Leverage Loan Index
A market value-weighted index designed to measure the performance of the U.S. leveraged loan market based upon market weightings, spreads and interest payments.
Characterized by lower price levels relative to fundamentals, such as earnings.
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