Three, two, one…blast off!

That was the reaction from global equities following a “Powell-ful” boost of positive sentiment stemming from frequent dovish FedSpeak and an increasing probability of future rate cuts later this summer. And just like that, one month after posting a 6% loss, global equities rocketed to a 6% gain in June—their best June return ever. Global stocks weren’t the only ones sent soaring: global bonds returned 2.2% in June, their best monthly return in over three years, and they are now off to their sixth-best start to a year since 1990.

With trade tensions cooling and global central bankers turning the accommodative policy thrusters on full blast, global risk assets appear to have landed in a Sea of Tranquility. Fifty years ago this July, Neil Armstrong and Buzz Aldrin definitely did! Navigating past an area littered with boulders, Armstrong landed the Eagle safely on the moon in an area known as the Sea of Tranquility. Much like the first men on the moon, policymakers are trying to navigate their way past a few objects and conduct a soft landing for the global economy despite the sharp boulders of slow growth dynamics and heightened geopolitical risk.

The big question as the summer gets under way, however, is does the market have "The Right Stuff" to keep this rally going? Two events in July will determine whether or not the market calls out, “Houston, we have a problem” or “All systems go”: the Federal Reserve’s (Fed's) July meeting and second-quarter earnings season. Meanwhile, trade will play the role of Michael Collins, the infrequently mentioned third man on the Apollo 11 mission. Trade will impact the market and be a determinant of success, much as Collins was needed to pick up Aldrin and Armstrong as they made their way back to the command module Columbia.

Asset class ETF flows: Bond flows are out of this world

Even with a 6% rally in global equities, investors allocated a record amount to fixed income ETFs. Equity ETFs did garner $20bn of inflows. However, June inflows to bonds were truly out of this world, with over $25bn—a more than 45% increase over the prior record, which was set in October 2014. Bonds’ record June haul pushed the first-half figure to $74bn, which is also a record amount for a first half.

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Source: Bloomberg Finance L.P., State Street Global Advisors, as of 06/30/2019. Past performance is not a guarantee of future results.

So why are investors buying so many bonds right as the S&P 500® Index hits new all-time highs and global equities are testing levels not seen since the December 2018 drawdown? It all goes back to one question: does the rally have the right stuff to keep going? As we continue to experience whipsaw volatility, investors all but require shock absorbers in their portfolios. And bonds are the type of shock absorbers investors have been using since before the time of Project Mercury; the record flows are evidence of their continued use.

Sector ETF flows: Are sectors saying “ready, jet, go!”?

Sector flows were anomalously negative heading into the month, at a time when the broader equity market had rallied back to new all-time highs. However, activity in June made it clear that the “Central Bank Put” was alive and well. As a result, investors put risk back to work with sectors, allocating over $3.5bn. This came just one month after sector strategies posted the worst month of outflows ever. Maximum G-force whipsaw-like volatility strikes again!

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Source: Bloomberg Finance L.P., State Street Global Advisors, as of 06/30/2019. Past performance is not a guarantee of future results.

These sector inflows have also occurred with a return of the options market. Open interest is higher (based on percentile ranking over the past two years) across all sectors from where we were earlier in the year, underscoring the tactical and sophisticated nature of ETF investors. This also signifies investors’ willingness to express risk with a bit of leverage, a positive sign with respect to how investors are positioning heading into the back half of 2019.

Another positive sign is that sector fund flows had a bit of depth to them and were not concentrated in one specific segment. As opposed to prior months, when multiple sectors had outflows, only two sectors had outflows in June—Materials and Technology. Counterbalancing the positivity and the notion that sectors are ready to proclaim “ready, jet, go”, the June inflows went to the more defensive/bond-proxy-type sectors. Real Estate, Consumer Staples, and Utilities ETFs took in nearly $3bn, a “search for yield” mindset in a world awash with negative debt.

Fixed income sector flows: Few bonds left in the space dust

The record flows for fixed income have predominantly gone into the more interest rate-sensitive sectors of the bond market (i.e., Government, Aggregate, Mortgage-backed, and IG Corporate), as investors continue to position for more episodic periods of volatility and seek to mitigate equity risk within portfolios. In short, investors are letting bonds be bonds.

But that’s not to say the credit, or more "risk-on", types of bond exposures have been left in the space dust. High yield ETFs took in a staggering $4bn during the month of June, pushing their year-to-date total to almost $10bn. The June flows equated to almost 10% of the start-of-month assets—the highest figure for any bond sector we track. High yield ETFs have clearly rebounded from a dismal 2018, taking in 25% of their start-of-year assets. And similar to the broad bond category, high yield ETFs took in the most flows for a first half ever. However, high yield was not the only “risk-on” type of bond exposure to witness a reversal. Fresh off posting the greatest outflows for any two-month period over the past 10 years, EM debt registered over $1bn of inflows—continuing its trend versus the dollar, as shown in the chart below:

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Source: Bloomberg Finance L.P., State Street Global Advisors, as of June 30, 2019. Past performance is not a guarantee of future results.

Does the market have the right stuff?

US stocks are at all-time highs, financial conditions have loosened considerably, and unemployment is at record lows. But what if the Fed doesn’t act, even though the economy’s jet engines are potentially running on fumes? A non-action by the Fed could be the summer surprise that has investors glued to their television sets like the world was back at 10:56 p.m. EST on July 20, 1969. With so many unknowns, and the trade truce with China a truce—not a treaty—continue to expect more whipsaw volatility. Investors may want to seek out exposures that allow for upside participation but can mitigate downside volatility. After all, Neil Armstrong used both rocket thrusters and shock absorbers to land the Eagle.

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. You can also access the full June ETF Flows report here.

Definitions

Bloomberg Dollar Spot Index (DXY)
The Bloomberg Dollar Spot Index tracks the performance of a basket of 10 leading global currencies versus the US Dollar.

Central Bank Put
A term used to describe highly accommodative monetary policy and the increased responsiveness of central banks globally to economic shocks and other crises.

FedSpeak
Comments from Federal Reserve officials

Maximum G-Force
The strongest gravitational force that can be tolerated by humans.

Open Interest
Also known as open contracts or open commitments, open interest refers to the total number of outstanding derivative contracts that have not been settled (offset by delivery).

S&P 500 Index
Standard and Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The index is widely regarded as the best gauge of large-cap U.S. equities.