May ETF Inflows Strong Despite Trading Jabs

Track shifting investor sentiment through our latest ETF flows analysis.

In boxing, the jab is the most important punch. Even if it doesn’t get the same visceral reaction as a well-timed right hook.

The jab is both an offensive and defensive effort — setting up more powerful punches as the opponent is forced to react, as well as allowing you to counter, gauge distance, or force an opponent to conform to your style. A well-landed jab can also be a knockout.

Thankfully, for the market, the jabs being traded among governments in this trade war are not the knockout kind. The back-and-forth tariffs and plans to use counter options amid legal battles are “opening” jabs to gauge pain tolerance and begin trade negotiations in a new era and style of political pugilism.

If, as they say, styles make fights, ETF flow trends illustrate a “stick-and-move” mentality.

Investors Head Overseas in Equities

Some of the US administrations jabs haven’t landed well. The initial tariffs have been deemed illegal and final all-in rates have been a moving target.

The trade war jabs also have left US capital markets vulnerable to a counterpunch. Inflation and unemployment forecasts have risen, while growth estimates — both fundamentally and economically — have declined,¹ reducing the US’s ability to absorb blows and backstop volatility.

At the same time, proposed legislation in the One Big, Beautiful Bill Act (OBBB) includes a potential tax on US assets held by foreign investors (S899).² This, combined with the move away from cooperation to coercion (i.e., mercantilism) to achieve national goals, may curtail foreign buyers’ motivations to own US assets.

With that backdrop, we have started to see the trend of US flow exceptionalism dip (Figure 1). While US equities’ $25 billion led in notional terms, it represented only 58% of all equity inflows — a large departure from both the prior 12-month trend (85%) and their share of total equity assets (80%).

The $9 billion into international developed markets helped this shift, as did the $2 billion into regional funds (mainly Europe). However, the $4 billion into single-country ETF exposures — the seventh-most ever for a month — really made the difference.

The inflows into single-country ETFs were also supported by increased depth (meaning it wasn’t just one country driving the flows). Of the countries tracked by ETFs, 76% had inflows in May, a large increase from the prior 12-month trend where only 44% of the countries had inflows.

There was depth at the fund level too, as 62% of all single-country ETFs had inflows — a rate well above the historical average 50%. The sizable inflows combined with two better-than-average depth rates reflect investors’ desire to:

• Invest overseas
• Express risk-on sentiment by moving away from large core positions
• Act tactically to separate winners from losers amid this paradigm shift in the global economic order

Sectors Reflect Defensive Tactics

One month removed from their worst month ever for outflows, sector ETFs posted a respectable $1.6 billion of inflows.

But despite the inflows, the level of optimism that fueled strong single-country flows is missing. Cyclical sectors had outflows, led by Financials, Materials, and Energy. But Industrials had $1.5 billion of inflows.

Beneath the surface, sentiment reveals what type of industrial markets are in favor. While funds focused on the broad sector had inflows, five out of the top seven funds in the Industrials classification with inflows in May are focused on the Aerospace & Defense sub-industry. This reflects increased geopolitical risks and the Trump administration’s legislative efforts to boost defense spending.

Defense industries were not the only defense being played within sectors.

With fiscal and monetary policy uncertainty still gripping market sentiment, defensive sectors had inflows in May (Figure 2). The $776 million into Consumer Staples and the $335 million into Utilities helped offset the outflows from Health Care — a segment caught in the middle of government policy changes.

Bond Flows Reflect a Flurry of Combinations

The softening of risk-off sentiment and the equity market rally led to a snapback in credit flows. Following the worst-ever outflows in April (-$18 billion) where all three sub-segments posted sizable outflows, credit sector ETFs rebounded with $12 billion of inflows spread across the three areas.

With equity market rallying, investors lightened up on their cash-like allocations, and short-term government bond ETFs saw outflows (-$3.2 billion). This comes one month after that bond sector had near record-setting inflows.

But the broader government bond sector still managed inflows (Figure 3). Long-term US Treasury-focused ETFs had $6 billion of inflows. While this may seem like a bullish signal that investors feel yields will fall in the near term, that may be a false takeaway.

Long-term US Treasury bond ETFs have seen a rise in short interest all year, and ETFs can be bought, lent out, and then shorted. And a bearish bet on long-term US Treasurys is not too farfetched, considering the fiscal deficit concerns, inflationary impulse from fiscal policies, as well as a mercantilist regime that has led foreign investors to question the appeal of owning US assets (i.e., proposed S899 in the OBBB).

Given the inflationary impulse amid the shifting economic order, inflation-linked bond (IL bonds) ETFs posted their fifth-consecutive month with inflows — their longest stretch of inflows since 2021 (Figure 4). Their year-to-date figure is now nearing $7 billion.

Focus on Resilience to Help Go the Distance

Right now, the market is enduring a jab fest. The fight could go the full 15 rounds, as it appears that the main combatants — US, China, and Europe — are all likely to keep trading quick rights from a distance. Coming into June, headlines indicate that the US and China are far apart, and that new steel levies will be placed on Europe.³

In Rocky, Apollo Creed lands heavy jabs on Rocky Balboa’s left eye for 15 rounds — causing eye damage and limiting his range of vision as a southpaw. In Rocky II, Rocky adjusts to this and fights from the right side.

Like Rocky, investors will need to adapt. This means ensuring balance with the necessary offense and defense to parry any oncoming blows — the range of outcomes (or tactics) in this new macroeconomic order is wide.

And because it’s unclear what round we are in, balancing portfolios across assets, geographies, and economic factors may help investors boost resiliency — like hitting the select button on Nintendo’s Mike Tyson’s Punch-Out!! between rounds.⁴

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