ETF investors grapple with ‘manic-depressive’ stock market after September flows signal ‘risk-favorable bias’

By Christine Idzelis

Good morning! ETF flows were ‘resilient’ in September, but have you looked below the surface? Citi saw “a clear risk bias.” Markets have been volatile as there is a “deep lack of conviction” as investors grapple with Fed-related anxiety, the chairman of Davis Advisors told MarketWatch in this week’s ETF Wrap.

Please send your comments and advice to [email protected] You can also follow me on Twitter at @cidzelis and find me on LinkedIn.

Money continued to flow into exchange-traded funds despite a turbulent September, but there were signs of wariness as investors continue to deal with sharp market swings and anxiety over aggressive monetary tightening by the Federal Reserve.

There’s been “a manic-depressive quality” to the stock market, Chris Davis, president of Davis Advisors, said in a phone interview. “You have this dramatic oversteer” both up and down.

Indeed, many investors harbor a “deep lack of conviction” about the direction of stocks, focusing on the weekly data that has fueled hopes and fears about the market and the economy, according to Davis. He also pointed to “extremely bearish” investor sentiment as the Fed aggressively raises interest rates, after holding them abnormally close to zero.

“What we’re starting to see is actually a return to normalcy — an unraveling of a massive distortion,” Davis said. “What terrified the market was a huge reversal.”

While ETF flows remained “resilient” in September, a look below the surface reveals that “a clear risk bias persisted over the past month not only in equities, but also in fixed income”, according to an Oct. 4 Citigroup research note. .

“ETF investors weren’t strong buyers as flows continued to focus on low-volatility exposures within each asset class,” Citi analysts said in the note. “September flows followed the persistent trend of conservative allocations year-to-date.”

U.S.-listed ETFs attracted $23.5 billion in net new assets last month, with U.S. equity funds leading inflows, according to the note. U.S. equity ETFs saw net inflows of $15.5 billion, followed by fixed-income securities with $11.4 billion, according to the report.

But “strong inflows of US stock trading ETFs can be misinterpreted,” Citi analysts warned. “A spike in shares outstanding could be a sign of continued short demand.”

Investors who sell stocks short are betting that they will go down.

Citi believed that “capital markets and options dynamics” influence the flows of heavily traded U.S. equity ETFs. Short-term interest has risen in these funds, analysts said. Although these funds saw strong inflows in September, “we doubt these are potential downside buys,” they wrote. “Instead, we suspect it was additional cover.”

“The Feeling Exceeds”

Citi this month lowered its year-end target for the S&P 500 by 200 points to 4,000, which is above current trading levels.

After strong back-to-back gains this week, the S&P 500 slipped 0.2% on Wednesday to close at 3,783.28. The index had fallen 9.3% in September for its biggest monthly percentage decline since March 2020, when U.S. stocks fell on COVID-19 fears.

The SPDR S&P 500 ETF Trust (SPY) fell 1.1% on Thursday afternoon, bringing its decline so far this year to more than 21%, according to FactSet data, at last check.

“Sentiment overshoots that factored in recession risk serve as the basis for our call for higher near-term risk,” Citi analysts said.

Read:The stock market is wrong: Economy won’t ‘blow a joint’ yet, economist warns

Meanwhile, ETF investors’ continued preference for low risk aligns well with weak sentiment readings Citi is seeing in its broader US equity strategy research, according to its Oct. 4 note.

The downtrend developed despite US-listed ETFs seeing September as “another strong month of new asset gathering”, with details below the surface of last month’s flows indicating investors were “Clearly ‘risk-averse’ buyers,” according to Citi analysts.

“Flows have been skewed to reduce volatility exposures across all asset classes,” they wrote. “It reflects the trend that has been in place all year.”

ETF investors have always been “more eager to make money work than other investor bases,” according to Citi.

In equities, the flow bias this year has been toward low-volatility and dividend-involving strategies, analysts said. “Investors avoided more volatile exposures,” such as small caps, “generally unprofitable themes,” and some single-country emerging market strategies, according to their research.

Meanwhile, stock market volatility has increased recently, with the CBOE Volatility Index trading around 30 on Thursday afternoon, according to FactSet data.

Citi saw the panic

“ETF investor reluctance coincides with falling gross and net futures positioning data as well as a level of Levkovich Index ‘panic’,” Citi’s proprietary sentiment indicator said. said bank analysts. “It hit ‘panic’ in September for the first time since the pandemic began.”

Davis Advisors clients have indicated a preference for U.S. equities over international equities, according to its chairman, Davis. “If people are freaked out, they don’t want to look internationally,” although international stocks look relatively cheap, he said.

The company’s Davis Select US Equity ETF (DUSA) is down about 22.8% in this year’s bear market, while the Davis Select International ETF (DINT) is down 19.7%, according to FactSet data based on Thursday afternoon trading.

But the company’s Davis Select Financial ETF (DFNL), which Davis says is substantially invested in U.S. stocks, has outperformed both of those funds so far in 2022. It’s down about 16.8% this year. based on Thursday afternoon’s exchanges.

“We tend to be very conservative in how we construct this portfolio,” he said, noting that he likes financial stocks in part for their dividend yields.

Hiding in bonds?

In fixed income, ETF investors have “avoided credit and interest rate risk based on flow data,” according to Citi. “Ultra short and short Treasury ETFs were the most popular flow gainers in September and year-to-date,” the analysts said.

Investors favored short-dated bonds after getting a higher-than-expected inflation reading last month, according to Matt Camuso, ETF strategist at BNY Mellon Investment Management.

“Ultra-short ETFs were a huge winner in terms of ETF flows in September,” he said. They were “buying things like one- to three-month Treasuries,” he said, “taking duration risk off the table” amid fears the Fed might have to maintain its aggressive path of currency hikes. rate to control stubbornly high inflation.

Read: These long-dated bond ETFs have cratered the most since their highs last year, crashing below other assets as the U.S. dollar soared

Camuso said investors were also “selling high yield” as they “tightened” their portfolios from a risk perspective, fearing the Fed’s hawkish policy could push the United States into a recession.

“Combined, the flow, positioning and sentiment data help support our near-term view that we may see a year-end risk reversal as the downtrend extends too far,” the analysts said. from Citi. “Nevertheless, our medium-term view is more mixed in the face of increasing Fed policy errors and serious recession risks.”

As usual, here’s your rundown of the best and worst performing ETFs of the week through Wednesday, according to data from FactSet.


Top performers                                                                                                                                                 %Performance 
VanEck Oil Services ETF OIH                                                                                                                                    15.7 
SPDR S&P Oil & Gas Exploration & Production ETF XOP                                                                                                            14.1 
iShares MSCI Brazil ETF EWZ                                                                                                                                    13.3 
First Trust Natural Gas ETF FCG                                                                                                                                13.3 
iShares U.S. Oil & Gas Exploration & Production ETF IEO                                                                                                        12.6 
Source: FactSet data through Wednesday, Oct. 5, excluding ETNs and leveraged products. Includes NYSE, Nasdaq and Cboe traded ETFs of $500 million or greater. 

…and evil

Bottom performers                                            %Performance 
Vanguard Extended Duration Treasury ETF EDV                  -2.6 
PIMCO 25+ Year Zero Coupon US Treasury Index ETF ZROZ        -2.5 
iMGP DBi Managed Futures Strategy ETF DBMF                   -1.8 
Vanguard Short-Term Inflation-Protected Securities ETF VTIP  -1.3 
iShares 20+ Year Treasury Bond ETF TLT                       -1.2 
Source: FactSet 

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-Christine Idzelis


(END) Dow Jones Newswire

10-06-22 1556ET

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