Massachusetts is known for its difficult roadways, characterized by a predilection for five-way traffic stops and counterintuitive highways. At one point, I-93 South turns into I-95 North, and we all think this is normal. Traversing these roads is akin to trying to understand the current market: Thanks to too many narratives (on- and off-ramps) combined with partial or transient information (detour signs and temporary roadways), no one can confidently say they know what is to come next.
It’s downright difficult to get a clear signal. The GPS is constantly recalculating, and information, as well as the type of data, changes day-to-day. To truly find a signal, data on economics, fundamentals, returns and COVID-19 cases must be carefully assessed—which includes removing anomalies and hyperbole.
The latest recalculation of my internal market-related GPS shows that the month of June might be our new normal life with COVID-19. After reopening, certain states have started to curb access as case rates surge, while others are getting back to normal but with extra precautions. Economic data has improved and small businesses are able to open their doors to a new, but uncertain, form of commerce.
Geographic ETF flows: Support for non-US focused ETFs
While US funds experienced the most flows, non-US focused ETFs had inflows of more than $7 billion during June, as shown below. A closer look at the data, however, indicates the flows may have been due to a single investor moving capital rather than a broader directional trend. At the regional level, 76% of the $3.7 billion flows were from one fund. Similarly, at the single country level, 95% of the $2 billion of inflows were from one fund. That said, removing these single-investor flows still leaves the respective categories in net inflow positions, along with the broader non-US category, which indicates sentiment around the space is indeed positive.
Another sign that investors are focusing on international exposures is found in emerging market (EM) flows, as the segment broke its four-month streak of outflows. EM topped US stocks by 6.7% in June, the strongest relative performance since 2012, bolstered by a better reopening of economies, a weaker US dollar and more constructive valuations.
Sector ETF flows: Riding cyclicals during the reopening
In aggregate, sector flows were positive for the third straight month, as shown below. Given that sector rolling three-month dispersion is in its 90th percentile historically,1 the potential for alpha generation from correctly choosing sector trades is likely fueling the constant flows.
The nature of flows has become more cyclically oriented. In May, four cyclical sectors (Consumer Discretionary, Industrials, Financials and Materials) saw positive trend reversals, switching from net outflows to inflows. This reversal largely carried into June, with Materials the only sector of the four to see outflows. Energy—another cyclical sector—also saw inflows in June.
Based on this apparent rotation, investors may be hopeful that a recovery will be more imminent with states and countries beginning to reopen, even as some actions are curtailed due to rising COVID-19 cases. Furthering this notion of a “reopening trade,” we saw historically defensive sectors—areas that held up well amid rising volatility, and are still outperforming the market year-to-date—post large redemptions in June, including Consumer Staples and Health Care.
Technology has been the one constant, registering inflows in twelve consecutive months – its second longest stretch on record (13 is the record). While not the record for consecutive months, it is a record, however, in terms of flow totals ($+14 billion) for Technology funds over any twelve month period ever. A sign of investors seeking out growth in an environment where growth is likely to remain challenged.
Fixed income ETF flows: Record inflows continue
Since the onset of the COVID-19 pandemic, fixed income ETFs have set records left and right. In March, bond ETFs set a record in terms of trading volume, trading more than $50 billion in a single day. The segment also set a record in terms of monthly outflows, witnessing $20 billion in redemptions. In April, following sizeable stimulus measures to support underlying liquidity in the capital markets, risk appetite returned and bond ETFs saw a near-record inflow of $22 billion, led by credit funds. The credit rally extended into May and bond ETF flows hit a new record of $28 billion.
The June inflows, however, outdid them all. As shown below, flows last month totaled more than $35 billion. The new record is 388% above the five-year average flow figure ($9 billion) and more than 291% above the 12-month average figure ($12 billion). Year-to-date flows into fixed income ETFs are close to $100 billion. In fact, if the year ended today, 2020 flows would be the third highest ever, even after including March’s record $20 billion of outflows. The year-to-date totals are also 63% of last year’s record $155 billion inflow. If this pace continues, the yearly record for flows could also be broken. Overall, the resurgence of inflows indicates confidence in the fixed income ETF vehicle, speaking to its flexibility in providing market exposures that allow investors to tailor portfolios in a liquid, transparent and cost-effective manner.
NextGen trends see strong inflows
The inflection point in our global society driven by COVID-19 is likely to lead to an increasing need for innovative technologies, allowing for more contactless interactions, advanced medicine, digital connectivity and intelligent infrastructure. As discussed in our mid-year outlook, some of these trends were already in place before the pandemic, but now, these changes are likely to be amplified as we transition to a more digitally connected—yet physically separate—world.
A tectonic shift of this magnitude may create tangible opportunities, and investors are likely to seek out specific exposure tools to capture one or all of the next-generation (NextGen) trends. As a result, thematic ETFs are likely to become more popular, which is why we developed a framework for classification as the first step in due diligence. We will now be reporting on the flow trends of the NextGen sub-themes as well as the category in aggregate.
The flows below show a strong preference for Broad Innovation, Cloud Computing and Future Communication—not surprising given the societal sea change we are witnessing. Overall, NextGen trend-focused funds took in $3 billion in June, a monthly record for the category. We believe this likely represents the start of an investment trend; it’s more than just an aberration. In June, 75% of NextGen trend funds outperformed the S&P 500® Index, and over the past three months, the average NextGen trend fund has outperformed the S&P 500 by 12%.2
Clearer market signals ahead?
In July, we are likely to get more information on corporate fundamentals when Q2 earnings season starts. Right now, the estimates look downright scary, but the estimates may be too harsh as firms seek to under-promise and over-deliver. Even with earnings, however, we still won’t have a full picture.
In today’s market, big up-and-down days are to be expected. There is a limited information edge as the market and the economy search for a signal. Under- and over-reactions to data will be the norm. In 2020, there have been more days with a daily move up or down 1% than typically seen in an average year.3 That is not a market with a clear signal.
Staying the course in terms of asset allocation diversification may limit any knee-jerk reactions while we are devoid of any clear signal. Investors, however, should not overlook the long-term opportunities emerging as a result of the change in consumer and corporate behaviors.
1 Rolling three month dispersion per Bloomberg Finance L.P., as of June 30, 2020, based on daily return data from 1998 to 2020.
2 Bloomberg Finance L.P., Federal Reserve as of June 30, 2020, calculations per SPDR Americas Research.
3 Bloomberg Finance L.P. as of June 30, 2020, calculations by SPDR Americas Research. In 2020 we have already had 68 days, compared to a full-year average of 60 days historically since 1980.
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