After more than 71% of global stocks closed 2018 in bear-market territory, equities rallied strongly to start 2019. Now it might be time for a “heat check”—a basketball term that refers to a player with a hot hand taking a particularly tricky shot to gauge just how hot he or she is.

The January rally may have legs, but last month’s pop may not be repeatable, given it started from such a low point after a fast and furious fourth-quarter selloff. One catalyst for the January hot hand has been increasingly attractive valuations: With markets entering 2019 on a somber note, US equities started 2019 trading 7% below their 30-year median next-twelve-months price-to-earnings ratio. In 2018, they started 20% above it.

However, markets’ pains from 2018 haven’t disappeared just because the calendar flipped. While it’s true that the percentage of global equities in a bear market has declined from 71%, the figure still remains at 59%. Not to mention 40 of the 47 (88%) countries in the MSCI ACWI Index remain in a technical correction, down more than 10% from their 52-week highs.

Given the recent post-correction gains, February will present several heat check moments, providing investors with tangible information on how strong the 2019 rally will be, including:

  • US earnings: The 2018 selloff was predicated on fears of slowing economic and corporate profit growth. Those concerns were correct—with half of the S&P 500® Index reporting results, only 70% of firms are exceeding expectations, the lowest level in two years and below the five-year average. Additionally, guidance is weak. With that, forecasts for first-quarter 2019 growth are now hovering around 2%, breaking a five-quarter streak of double-digit growth.
  • A confluence of macro and geopolitical events: February will bring an excess of data releases that were not previously disseminated due to the recent US government shutdown. Given economic sentiment outside the US has waned—notably in Europe and China—it may not bode well for risk assets if the US has a similar trajectory. Beyond the data releases, investors will also have to maneuver past another shutdown fight. Note, too, that a debt ceiling debate will be thrown in for fun, as the suspension period for the nation’s debt limit ends March 1st.

Markets are also facing the prolonged and dysfunctional break-up that is Brexit, ongoing political strife in the Eurozone and an emerging crisis in Venezuela with ramifications for the oil market. The outcomes, or even the latest news, could put more points on the rally board or send global equity markets to the bench.

Let’s take a closer look at how investors used ETFs to position themselves during January’s rally and in anticipation of a February heat check.

Asset class ETF flows: Bonds from way downtown

Even with the market’s sizeable gains to start 2019, flows into equity ETFs were net negative, pushing the entire US-listed ETF industry into net outflows. Some of this may be attributed to less-than-positive market sentiment, as evidenced by certain technical indicators which aren’t flashing the all-clear sign. The outflows are also attributable to cyclical rebalancing: January has brought monthly outflows 52% of the last 20 years—the highest percentage for any month of the year.

Fixed income ETFs, on the other hand, took in more than $15 billion last month, notching their third consecutive month of inflows of $10 billion or greater. As shown below, January brought a massive rotation into bond strategies as investors sought the potential defensive properties of fixed income during the recent bouts of equity volatility—the textbook use-case for bonds.

Regional equity ETF flows: Emerging markets gain traction

As shown below, US exposures led the decline in equity ETF flows, posting more than $20 billion of outflows. Equivalent to a 1% loss in assets, the January outflows completely offset the segment’s December inflows.

Emerging market (EM) ETFs, however, amassed inflows for what appears to be market-driven reasons. EM funds have posted inflows for three consecutive months—and those three months rank as the highest three-month fund flow total on record. This is also the first time that EM funds have led our monthly geographical flow analysis. If markets are inherently volatile and geopolitical risk is elevated, what’s driving the allocations to EM?

It’s largely related to value. EM equities sold off during most of 2018 while the rest of the market chugged along for the first nine months of the year. At one point, EM equities were down 27%. This precipitous descent led valuations on EM stocks to become too attractive to ignore. A sideways-trending US dollar has also benefited sentiment in the past three months, with a gauge of EM currencies appreciating 3% since the end of September 2018.

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Source: Bloomberg Finance L.P., as of 1/31/2019.

Sector-based equity ETF flows: Stars on a losing team

Sector-related equity strategies saw net outflows of $9 billion in January, pushing flows negative for the fourth month in a row—the longest stretch on record. The negativity was felt by almost every sector, as only four had inflows: Staples, Utilities, Health Care and Communication Services.

For Utilities, Staples and Health Care, January was a continuation of recently witnessed defensive positioning within sector-based strategies. It’s not a surprise to see investors favoring these areas given their historical performance trends during slowdowns.

The chart below illustrates how many tactical sector rotation strategies have likely rotated out of the “market” and into more defensive exposures, like bonds as noted above. The rolling three-month flow figure for US equity sector-focused strategies has now registered a three standard deviation event, so watch for mean reversion.

Managing the heat check: Seek out two-way players

Looking ahead, a more “patient” Federal Reserve will likely serve as a short-term adrenaline rush. More importantly, the US market is returning to normal bouts of volatility. Therefore, rather than focus on the recent hot hand, investors may be well served by seeking out two-way players who have scoring potential and can play defense when the offense isn’t clicking.

To be clear, we don’t expect an imminent recession. However, the recent rally will get a heat check soon, and that may bring more volatility. As a result, we are constructive on defensive equities that trade at inexpensive valuations but have quality balance sheets, as well as defensive short-duration bond strategies that generate income similar to broad exposures, given how flat the yield curve has become.

Stay current on what State Street Global Advisors is seeing in ETF flows: Follow SPDR® Blog and check back monthly for my ETF Flows post.


A free-float weighted global equity index that includes companies in 23 emerging market countries and 23 developed market countries and is designed to be a proxy for most of the investable equities universe around the world.

Price-to-Earnings Ratio (P/E)
The ratio of the price of a stock and the firm’s earnings per share. A lower P/E indicates cheaper valuation.

S&P 500 Index
A popular benchmark for US large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.