My family played a lot of board games over the holiday break, including Chutes and Ladders, a game with play reminiscent of 2020’s market activity: Positive movement marked by big up days (landing on a ladder) as well as down days (hitting a chute), but overall, more up movement than down.
In the fourth quarter, bolstered by positive vaccine news and a resolution of election uncertainty, it seemed to be all ladders as the broader global equity markets posted their eighth-best quarterly return ever, pushing 2020 returns well into double digits (+14.3%). The strong returns, however, occurred only a few months after the market “hit a chute” and experienced the second-worst quarterly return on record when the pandemic first gripped the global economy in Q1.
As a result of this boom/bust activity, 2020 is the only calendar year to ever see global stocks post a quarterly return in both the top ten (Q4) and bottom ten (Q1) of all time. Yet not all investors had the same experience. To new entrants into the retail day-trading community, stocks seemingly only went up. Value investors witnessed losses in a year of outsized gains as they couldn’t pull themselves out of the Q1 chute before the year was over.1 Standard sixty-forty portfolios, despite a few bumps, steadily navigated the year, never finishing in the bottom but never winning, either.2
Overall, Chutes and Ladders is a game of chance predicated upon a spin of the wheel. With the pandemic creating outsized idiosyncratic macro risk, this spin-of-the-wheel mentality was very much on display in 2020, as the CBOE VIX Index registered 218 days above a level of 20—a day-count figure that is more than the past eight years combined. And just because the calendar has flipped to 2021, it doesn’t mean the game of Chutes and Ladders we played in 2020 will change.
Asset class ETF flows: A banner year for fixed income and gold ETFs
In December, markets struck a decidedly risk-on tone and investors turned to ETFs to implement positions quickly and with precision. ETFs registered their third-largest month of inflows ever, gathering more than $64 billion. This comes after posting a record $94 billion in November, leading to the best back-to-back months on record for ETF fund flows and the best quarter ever. Notably, full-year figures zoomed to a record $505 billion. This record haul drew heavily on strength in fixed income and gold ETF flows. As shown below, fixed income ETFs took in a record $212 billion thanks to an ongoing secular shift into the asset class. Gold-backed ETFs took in a record $29 billion—a staggering 148% more than the previous record haul from 2009.
Geographical equity ETF flows: International equities gain traction
As shown below, six of the seven geographical categories we track posted inflows in December, with Currency Hedged the lone segment with outflows, albeit minor. Funds focused on equities beyond the US took in $30 billion compared to $15 billion of inflows into US-focused ETFs.
With equity markets buoyant, the strong flows into equities are not a surprise as investors sought to deploy cash and ride the rally higher. The uptick in interest into overseas equities is also not that surprising, considering the stronger returns relative to the US in December, as well as over the past three months for International Developed and emerging markets (EM) equities. In the latter period, these two markets outperformed the S&P 500® Index by 4.1% and 7.7%, respectively.3
The renewed interest overseas, and particularly in EM, comes at a time when economic growth in 2021 is expected to be stronger internationally—led by China—than in the US.4 Geopolitical uncertainty has also decreased (to a degree) with a more predictable approach by the new US administration alongside the reduction in fears of a hard Brexit after a deal was reached.
Sector ETF flows: Rotating to cyclicals
Sector-focused equity ETFs registered $7 billion of inflows in December and more than $20 billion for the quarter, as shown below. Throughout the year, investors favored the Technology sector, which gathered the most flows of any sector in 2020. However, with the hope of a recovery closer on the horizon following positive vaccine news, investors shifted their focus toward cyclicals and leveraged the precise nature of sector-focused ETFs to rotate into market segments more commonly associated with the recovery phase of the business cycle. Cyclical sectors outpaced defensives by $9 billion last month and by $21 billion over the past three months.
Financials led the cyclical pack for the quarter, taking in $5.2 billion. If an economic recovery does take shape, cyclical assets are likely to benefit as a result of the broad-based increase of economic growth, with bank stocks potentially representing the ideal cyclical change candidate for 2021.
Fixed income ETF flows: Record-breaking 2020
Bond ETFs broke past the $200 billion mark for the first time ever in 2020, registering inflows of more than $10 billion in 11 out of 12 months—a record stretch. As shown below, by year’s end, only one segment was in net outflows (Bank Loans); however, sentiment has begun to turn as the sector took in $1.3 billion over the past three months. Since the onset of the pandemic, investors have gravitated toward the ETF structure for bond exposure, as a result of the vehicle’s low cost, transparency, market coverage and liquidity.
In this abnormal yield-starved environment, generating income on par with historical figures requires investors to outlay more risk—a trade investors are more willing to take given the positive macro news. I’d expect this trend to continue, as loans, EM debt, and preferreds provide income in our low-rate world without completely forcing a portfolio into generating income from just one specific “risk bucket” (i.e., currency for EM debt, credit for high-yield bonds/senior loans and hybrid for preferred stocks).
Risks and opportunities amid a rocky recovery
In 2021, we will still have to deal with the “chutes” of rising COVID-19 case rates and an uneven vaccine rollout. Accommodative global stimulus programs (a ladder) should support broad equities and some of the butterfly effects from the disruption to daily routines (e.g., videoconferencing, mobile payments, intelligent infrastructure) may continue to propel certain segments higher, as they did in 2020.
With this backdrop of both risks and opportunities amid a likely rocky recovery, as discussed in our 2021 outlook, we feel there are three potential ways forward in the market’s game of Chutes and Ladders:
1S&P 500 Pure Value Index was down 8.7% in 2020, Bloomberg Finance L.P. as of 12/31/2020
2A 60/40 allocation of the MSCI ACWI Index and the Bloomberg Barclays US Aggregate Bond Index return 11.6% in 2020, Bloomberg Finance L.P. as of 12/31/2020
3Based on the return of the MSCI EAFE and MSCI Emerging Markets Index
4IMF World Economic Outlook, October 2020
CBOE VIX Index: The Chicago Board Options Exchange (CBOE) Volatility Index shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options.
S&P 500 Index: A stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
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