This year is a flat circle: everything we have seen, or will see, we are going to see over and over again.
The Brexit debate rages on, constraining sentiment for European equities and curtailing economic growth within the region. Trade tensions have ebbed and flowed all year. Unrest has returned to the Middle East along the Syrian border. And in the US, congressional inquiries into the executive branch have grabbed headlines and exacerbated political gridlock, stifling meaningful pro-growth legislation.
At the same time, global equity markets are up double digits in 2019, and US stocks have hit all-time highs.1 The standard 60/40 portfolio has posted its second-best yearly return over the past 10 years,2 and more than 60% of the 47 countries3 in the MSCI ACWI Index are higher than they were prior to 2018’s sizable fourth-quarter drawdown. But while global stocks may have recovered, current positioning suggests that the events of late last year are still fresh in investors’ minds.
Asset class ETF flows: Bonds break records
Equity investors celebrated the eighth month of global stock gains by allocating $10 billion to equity-focused ETFs. While a net inflow, this is the lowest monthly inflow total for the year. The current environment has left investors unwilling to consistently express a risk-on view all year. Even if November and December see $74 billion of inflows—the average for both months combined over the past five years4—it’s unlikely that equity ETFs will surpass $200 billion in 2019, breaking a two-year streak.
While equity funds have had dour flows, bonds have been breaking records. Nearly $130 billion has gone into bond ETFs in 2019, putting assets firmly over $800 billion. If the next two months keep up 2019’s average flow-gathering pace, US-listed bond ETF assets could surpass $850 billion by year’s end—with a realistic shot at surpassing the $1 trillion mark in 2020.
The chart below shows the rolling three-month fund flow totals for fixed income ETFs dating back to 2005. This figure is near an all-time high for the most recent three months ending in October, with over $44 billion. It is also $20 billion more than the five-year median for this metric. What is interesting is that the rolling three-month metric has been above that five-year median for 11 consecutive months.
Fixed Income: High Yield at All-Time Highs
The record-breaking flows in fixed income seem to have been driven by two different market-related motivations. With geopolitical risk whipsawing sentiment all year, interest-rate-sensitive sectors (e.g., Government, Aggregate, and Mortgage-Backed) have taken in nearly 64% of the flows as investor seek areas for downside risk mitigation. At the same time, with a dearth of negative-yielding debt and accommodative global central bankers pushing investors further out the risk curve to generate yield, flows into high yield ETFs are on pace for a record year—indicating that investors are looking for yield at any price.
Sector ETF flows: Can’t catch a break
Up until the last two days of the month, sectors were in outflows. They managed to finish the month up a bit, continuing their up-and-down trend that has produced four months of outflows and six months of inflows over the first 10 months of the year—nearly an even split.
At the sector level, flows were a bit of a random walk. There were inflows into trade-on related sectors, and outflows in some defensive areas. Some growth-oriented sectors had outflows (Technology, Communication Services), while some value sectors had inflows (Energy, Financials). The defensive/rate-sensitive trade that we have witnessed over the past few months, inflows into Real Estate, Utilities, and Consumer Staples, seems to have slowed a bit. And somewhat counterintuitively given performance, investors continue to rotate out of Health Care.
The chart below shows that only four sectors have experienced inflows on over 50% of the days in the past month, signaling uneven and somewhat downbeat sentiment.
Source: Bloomberg Finance L.P., State Street Global Advisors, as of October 31, 2019. Past performance is not a guarantee of future results.
In what is perhaps an encouraging sign for Financials, the sector not only had strong notional flows in October, but on more than 50% of the days last month, it had inflows—a change from prior trends.
Mind the Volatility Gap in Stocks
Using our proprietary classification scheme, we have broken down smart beta flows by factor type. Like previous periods, the majority of the flows have gone to defensive-oriented factor exposures. Quality has seen the largest increase as percent of assets in 2019. However, Minimum Volatility has taken in 40% of all smart beta flows in 2019 and was second in terms of flows in the month of October, behind Dividend Exposures.
Overall, the defensive factors of dividend, minimum volatility, and quality have taken in 113% and 88% of all smart beta flows in October and 2019, respectively. And as stated earlier, the $7.9 billion into those factors in October was a sizable 73% of all equity flows.
What to do while waiting for the cycle to break
Depending on how you view the data, there could be more room to run in this rally…or it could be uneven, fragile, and knocked off course by one of the many exogenous events. Or 2019 is a flat circle, and it doesn’t matter. To maintain some sanity on this journey, consider equity strategies that seek to limit the impact of any “volatility drag” on returns, while retaining upside participation potential.
1“S&P 500 hits fresh all-time high, boosted by strong earnings and US-China trade progress,” CNBC October 28, 2019.
2Bloomberg Finance L.P. as of 10/31/2019, based on a 60% MSCI ACWI IMI Index/40% Bloomberg Barclays US Aggregate Bond Index mix rebalanced annually. In 2019, the 60/40 mix is up 15.0%. Past performance is not a guarantee of future results.
3FactSet, as of 10/31/2019.
4Bloomberg Finance L.P., as of 10/31/2019. Calculations by SPDR Americas Research.
A term for the withdrawal of the United Kingdom from the European Union.
Dividend Yield Factor
Characterized by stocks, or a basket of stocks, with a high dividend yield.
Minimum Volatility Factor
Characterized by stocks, or a basket of stocks, with a low standard deviation of returns or a lower risk than the market.
Characterized by stocks, or a basket of stocks, with a more stable earnings growth and less debt held on their balance sheet.
A term for rules-based investment strategies that don’t use conventional market-cap weightings.
Trailing Three-Month Average
Average over the prior three months.