ETF Edge - European Recession Priced In?

Episode Date: March 14, 2022

CNBC's Bob Pisani spoke with Arne Noack, Head of Systematic Investment Solutions, Americas at DWS Group, Charles Rotblut, Vice President and Financial Analyst at AAII and editor of the AAII Journal, and Andrew McOrmond, Managing Director at WallachBeth Capital. They discussed the resounding ripple effects from Russia’s war on Ukraine … how do ETF investors navigate the many layers of chaos the market is facing both in the U-S and overseas? Is Europe pricing in a recession right now? What about the slowdown in China? And how are retail investors handling all the uncertainty? Are they hitting the panic button yet? We’ll have all that and more. In the 'markets 102' portion of the podcast, Bob continues the conversation with Andrew McOrmond at WallachBeth. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, Supporting the Innovators Changing the World, Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis, breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll talk about the resounding ripple effects from Russia's war on Ukraine. How do ETF investors navigate these? layers of chaos the market's facing in the U.S. and overseas?

Is Europe pricing in a recession right now? What about the slowdown in China? And how are retail investors handling all the uncertainty? Are they hitting the panic button? We've got that and more. Now, here's my conversation with Arnie Noak. He's the head of systematic investment solutions for America's at DWS Group. Charles Rotblut is the vice president and financial analyst at the American Association of Individual

Investors and editor of their journal. and Andrew McCormon is the managing director at Wallach Beth Capital. You know, guys, I can't think of a time when there are so many macro issues for investors to address inflation, Ukraine, China, and the Fed hiking rates just the most prominent. Andrew, your specialty is the execution of large blocks of ETFs in and out of the marketplace for insurance companies or pension funds. How are your clients managing these risks, and what are you telling them to do now about Ukraine and the inflation issue? So obviously we're seeing a lot of trades, a lot of large blocks.

Today we saw a large IEMG, which is emerging markets, outflow into GOVT. So they're doing that. Their flight to safety, I mean, treasuries may not be the best place, obviously, to get a return with everything going in the U.S., but they are definitely risk off at that level. Yeah. So, Arnie, you run several Europe-based ETFs, including several that are currency hedge. Several of them were, oh, 15% or so off the recent highs. Tell us about Europe.

Is Europe pricing in a recession over there? And can you talk to us about the value of using currency hedged investments? Because I know that that's one of the specialties for DWS. Yes, thank you, Bob. Yeah, certainly the flows into European ETFs have been interesting this year. Year to date, we're still up around about $100 million in terms of flows across the market in European equity ETFs. However, over the last past two weeks, flows have turned significantly negative. what we tend to say to our clients is it's very much worthwhile knowing about your risks,

knowing about what type of exposure do you hold with your ETFs. Because as you just said, Bob, currency hedging or not currency hedging really matters. If we look at the current situation in Europe, equity markets are down, but so are currencies against the US dollar. So when we in particular look at the Eurozone ETFs, the unhaged part underperforms, part by almost 6% year to date. So investors, unfortunately, who didn't hedge the currency in the beginning

of the year, received a bit of a double whammy here. So it really is worthwhile knowing about the risks in the ETIFs. Yeah, you know, Andrew, he makes a good point. We never talk about this, but he has a DBEF, which is the EFA, Europe, Africa, Far East

hedged equity. MSCI essentially tracked the same indexes, but the unhedged one is down much more than the hedged ETAF here. EFA is the hedge one. Yeah, the ETF community has done a great job of putting these products out. Arnie, you'll tell you, this product has been

out. And it's fair to say maybe without the turmoil that we're in right now, it was more of an even performance. But you have to pay attention. As soon as something happens and we're going to have inflation with this U.S. dollar, you absolutely must hedge. So it's a great way to change. And you're keeping the same exposure. You're just hedging.

What you're doing in a volatile market. Yeah, it's a very good piece of advice. Arney, You also run the China A-Shares E-TF, which is a basket of stocks that trade in mainland China, A-Shars. What kind of flows are we seeing in those particular funds? And can you explain some of the very wide discrepancies in some of these China ETFs this year? So your fund, A-Shars, A-S-H-R is the symbol, is down about 12%. But the A-S-S-E-I-China, the symbol M-C-H-I, also a basket of China in stocks, is down twice as much. 26%.

Yes. So Bob, again, sort of in a similar vein, it's really worthwhile as the ETF investor knowing what is actually in the ETF. As you just alluded to, ASHR holds domestic onshore Chinese equities. Of course, they haven't done as well as probably some investors have hoped. We saw at the end of last year, fairly decent inflows into our product. Those have stalled a little bit and to a little bit of a degree reversed over the last two weeks. However, performance has held up, especially when comparing to some of our competitors.

And so what I mean by knowing what's in the ETF is especially when it comes to exposure to China, there is a lot of different options out there. You can invest, of course, via ASHR in the domestic Chinese companies, companies, you know, let's say the 300 largest onshore markets, onshore equities in China. Or you could use an alternative product that invest in Hong Kong listed stocks or even in New York. for London listed stocks. Of course, with the SEC and the ongoing discussion around financial disclosure requirements here in the US and the emerging talk around potential delistings here from New York, from the New York Stock Exchange,

some of those companies are receiving a worse treatment from investor sentiment and standpoint than onshore domestic Chinese equities. So those, that kind of differentiation can potentially explain some of the performance differences we've seen yet today. It's really kind of remarkable, Andrew. You think the stocks are fungible. You know, they should trade the same way in mainland China and Hong Kong and here.

And yet there is a differential. Stocks listed here, China stocks, down, different kinds of regulatory pressures that we're seeing on. There's a lot of risk on the duly listed names. I do like that those are the mainland China stocks. And again, it just comes down to a percentage of allocation. The large companies that we deal with, sure, they have 2, 3% in China. That's not going to hurt them. But as an individual investor, do you really want to sell your Netflix?

and take a big bet on China right now, I think there's a lot of risk in that. Well, what kind of allocation are you recommended to these big pension funds? The U.S. pension funds, right, and U.S. insurance companies, they have global asset allocations now, too. Are China stocks investable or uninvestable at this point?

What are they telling you? His hedge Europe is going to do really well. Countries where you can still get commodities, weightings, right? If a company produces commodities, you can see that those are not performing, or performing better than tech-heavy. Like, Asia can be tech-heavy.

You know, it's not just professionals, folks. Retail investors are having a very tough time figuring things out. Charles, one of the reasons I had you here, you are the American investor, the retail investor. The American Association of Individual Investors, which you represent, is a mainstream retail investor group. Your investor sentiment survey, which I watch every week. We're watching it for many, many years, showed 46% of respondents bearish. That is way, way above the average.

just about 30%. What's got the average investor worried right now? You know, I think it's a combination of factors, Bob. The volatility we've seen in the markets is certainly playing a role, as is Ukraine. But we also have inflation. And a lot of investors obviously see inflation front and center. I think in a mix of all that, we also have the uncertainty of a rising interest rate environment. How much is the Fed going to raise? Right now, it looks like next week we'll get a quarter point instead of half a point, but obviously what happens after that matters. And then I think we, and as I mentioned to you before, we also have this role of politics at play where the political views come into play as well. And so those who maybe are more conservative, they're more dower on the markets, have a more fierce outlook in general.

And we see a similar type of thing play out in the Gallup polls where they look at how people view the economy. by the partisan affiliation, that plays a role. But I think if your average investor, you're looking at higher food and gas prices, you're looking at volatile markets, you're looking at interest rates rising, and you've had this big run in stocks since the coronavirus bear market bottom.

So I think it's a combination of factors at play here. I'm always interesting to see what your membership is owning these days. You did a survey recently. of what your members own. You just ask them what they own. And I think it's interesting. We'll put this up. 91% own individual stocks.

That makes some sense to me. But 75% own ETFs, more than they own mutual funds. I think it's 72 or 3 that own mutual funds. And here's something very interesting. Only 6% own cryptocurrency. Now, we make it such a big deal of the Robin Hood crowd that they seem to own nothing but cryptocurrency.

And yet the average investor, I think of AAII as the average retail investor, only has 6% crypto. So this tells me, ETFs are really making inroads into the average mainstream investor and even more so the mutual funds. And cryptocurrency, while it's there,

is still a pretty small business for the average retail investor. Yeah, it is. And part of it at plays our demographics. Although we have a very broad membership of about 160,000 members, we tend to skew towards older, investors, our average investors in their 60s or 70s in terms of age. And I've seen that at other

organizations that target individual investors. So that's something at play right there. I think a lot of individual investors, when they look at crypto, they're still not quite sure what it is, how to value it, how to even buy it. So I think there's some of that at play as well, whereas your people who are, say, Gen Z or millennial are more comfortable doing that. But I think what you seeing ETFs and stocks is I think you have a lot of people using ETFs either for broad allocations or perhaps to get to things like international or bonds, but they're using stocks. And what I've seen over the course of my careers, people might be pretty mainstream with their mutual funds or ETFs going for index approaches. But then either they're tilting towards value, they're

incorporating trading strategies, perhaps covered call options. So they're mixing the two where part of their portfolio is probably more traditional, more conservative allocation, but then they're using stocks to perhaps be more aggressive or supplement those holdings. Single stock risk, too. Yeah. What were you saying? Single stock risk. I mean, you know, COVID was, once we realized their world wasn't going to end, it was like,

okay, buy stocks, right? And this is a far more complex problem. And I think if you said it was older, wiser, or at least investors that have been around the block, let's say, and haven't just had a bull market, they're going, it's time to take single stock risk off the table and have some ETF allocations. That's where I think that growth comes from. And I wonder, Charles, and I realize that Russia's attack on Ukraine and rising inflation, have put commodities into the spotlight. We've been covering commodities for weeks on end here on ETF Edge. But one of the things I always remember about you is you've always

emphasized to the members, it's really important to do your homework before you add commodities to your portfolio. What is it about commodities that the average investor should be really careful about? Well, I think when I look at ETS or mutual funds, they need to be very clear about what they're investing in. And my latest commentary last week, my investor update commentary, I used a combination of looking at the spider gold GLD, and then there's a gold bugs, which is an ETN GBUG. When you buy spider gold, you're actually buying a trust. So not actual gold. You're buying a trust that holds physical gold versus the G-bug. actually invest in futures contracts.

And so it's a case where you're getting exposed to gold two ways, but both times you're a little bit to step away. And anytime you start getting involved in futures contracts, you have to realize those contracts are going to expire and it be rolled over. But even if you just buy a plain commodity ETF, it could be holding futures, it could be holding assets. It could also be holding individual companies. And if you're looking at individual companies, say Halliburton,

bear gold, whichever company you want to pick out or deer, you're looking at operational risk there. You're looking at stock-specific risk. So it's not really a case where you should judge an ETF by its name. You really should take a look, see what the ETF's doing. And even among commodity ETFs, see what their allocation is because their exposure to precious metals, to energy, to agriculture, might actually be different by the type of fund far the exchange traded notes you're looking at. Are you getting a K-1?

Yeah, it's caused no end of problems for years and years explaining just roll over risk and owning commodity futures, let alone. Yeah, the bigger ones, the more risk. We saw that with the oil ETF, remember what happened. Now, Arne, let me bring you back in. You run, this is a slightly different subject, but I'm always fascinated a bit, is you run the emerging markets carbon reduction and climate improvement ETF. That's a mouthful.

is EMCR, and it basically tracks an index of emerging market stocks that are selected based on whether or not they're reducing their carbon footprint. It's sort of like a play on the net zero economy. But prices for these carbon emissions have collapsed. This is interesting in light of what's going on in Ukraine. Can you explain why that's happened and what impact has this had on the whole movement towards lower zero emissions? Yes, Bob, this is actually a very interesting topic. bring up in the current sort of scheme of things. The topic of carbon reduction and climate risk, obviously before the most recent incursion onto Ukrainian territory was really at the top of the

agenda for many of our investors. EMCR is a fund that was launched relatively recently. In August of last year, we brought it to market. In a relatively short period of time, it managed to gather over $700 million of assets from institutional investors. So that goes to show that really there is demand for that kind of net net zero type of carbon reduction strategy. And what EMCR does, it's still, it's not a thematic ETF. It's not an ETF that banks on, let's say, you know, carbon-efficient industries in any way, but it is very much a broadly diversified emerging market index that really seeks to track in a way any market capitalization weighted index.

However, it also at the same time seeks to reduce the carbon footprint by 60% and have a year-over-year carbon reduction inbuilt to itself by 7%. So it is really something that, especially in the institutional investor community, we see at the top of the agenda. Of course, with recent geopolitical news, that agenda has shifted somewhat, very understandably. However, in the medium term and most certainly in the long run, the topic of climate change in carbon reduction and the importance of carbon reduction strategies will for sure come back onto a broader agenda. I'm personally relatively sure about that.

So it's like a double whammy here. I mean, I'm looking at what you own, Taiwan semi, 10 cents, Samsung, Alibaba. They've all gotten hit in the global slowdown, number one. But number two, I mean, prices for the carbon emission. business in general have collapsed a bit because of what's going on in Ukraine. The emphasis is going to be on hydrocarbons now in the near future. So that's the two-prong problem here, Arnie. Is it right? Am I right about that?

So just to avoid confusion, we're not actually trading any carbon credits or futures and carbon credits in our product. We just hold stocks. We're a long-only portfolio of emerging market companies. And yes, of course, that portfolio has suffered alongside the standard market cap benchmark. However, since its launch, we've actually seen a fair bit of outperformance, ever-so-slide, outperformance, I shall say, of EMCR compared to a market-cap-weighted benchmark index. So the suffering in terms of the carbon price has no effect really on our portfolio.

We're still exposed to companies that have a plan to actually better their value chains for the purpose of medium-term climate change. And is this going to change the whole conversation, the Ukraine thing, around a whole environmental discussion? It should. I mean, ag tech. I'm talking about ESG in general, but it's a part of ESG. I think it adds to that. I think we're going to be with, obviously, I think we're going to be not using Russian wheat for a long time.

That's just my opinion. So you're going to have agriculture. And carbon credits and agriculture is a huge trend. That's going to be part of ESG. We'll be talking about that next year, like it's the biggest topic around. Yeah. where that's going to go, but it seems, it has to affect the whole ESG story, a whole environmental story somehow, and the investing in the ESG.

I mean, it never always amazes me that when you look at these big ESG funds, they're always tech-oriented because in a sense, you know, they're like large growth companies. Right. How do we get rid of this? How do we get rid of that? How do we stop doing this? That's what they're about. It's very, very difficult.

Charles, any other thoughts on what the retail investors are telling you right now what your members are really interested right now, other than trying to figure out what inflation is doing, which we all want to know. Yeah, and the one nice thing is a lot of our members tend to be long-term investors. So I would say the one thing we do have, particularly among our members who are retirees, is really just that income portion of the portfolio. That's been a challenge for years, as you know, with interest rates being so low, and it continues to be a challenge. So while they might be worried about the impact of interest rates on the stock market, there's some also somewhat relieved that at least, you know, on the income side of their portfolio,

they should be getting a little bit more in. And I do think there's a general sense that the Fed needs to raise rates just to combat inflation. But that is something they're definitely paying attention to. What are yields? And what can they be in a situation where perhaps they can actually count on something besides dividends to give them a reasonable yield and some cash flow? Yeah. It's been noted. I've done several stories on this. Record dividend payouts in 2022, it looks like. Record buybacks, it looks like. Record cash flow.

I don't know if capital expenditures is going to be in a record. That's what a lot of people would like to see. But certainly companies like the oil companies are going to get oceans of cash flow. But there's risk. If you look at the Y, G and the J&K to stay on the ETF topic, outflows. There's, you know, higher yield, more risk. Yeah. Yeah, that's simple.

Now it's time to round out the conversation with some. analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of our podcast. Today we'll be continuing the conversation with Andrew McGorman at Wallach. Beth. Andrew, thanks for sticking around. I want to just talk about what you as an observer of the ETF business are seeing. How are ETFs growing?

And I have you on because you talk to institutional clients. You talk a lot to pension funds. You talk a lot to institutions, to endowling. Are they expanding their use of ETF? Do they have concerns? What's going on now? Yeah, they are. I mean, first of all, it's funny, that's the big money, right?

The big money, these five million share blocks that we do, or it's an institution, it's not obviously retail investor. But they actually move like a cruise ship. So they're getting to the end of this bull run, right, that we've had, let's say six months ago. And that would include the COVID run. And they're saying, okay, let's have an investment committee meeting, let's go over our process. this manager's not doing well. And they look in real time, and an active manager,

most of them are actually underperforming this latest correction. So when they look at it, they go, you know, they wouldn't hedge right away or they're caught off guard. Really, active management's going to shine as we come out of this,

because are they getting out at the right time? They're able to pick the right things where Vanguard just staged the course. But the institutions and endowments that hire these active managers, they're saying they're underperforming, we're under pressure. We have to raise certain amount of assets

to either satisfy our liabilities, its insurance company, or if it's a pension, right? They have pensioners that have to get paid their percentage. So what are they doing? They use ETFs as transitions. Now they're literally using ETFs as the managers. It's a much lower cost. And if you look at the lagging performance, they are outperforming active management.

That's where the growth in the institutional side is. Really? Now, what about the younger investors out there? We always tend to talk about the Robin Hood investors. Robin Hood's got 20 million accounts. Right. But I just had it on, we had a very interesting discussion. you and I were Charles Rothblood, he is the vice president of the American Association of Individual Investors.

He noted, and they have 160,000 members, mostly older. Mostly older. Not Robin Hood people. And 90% of their members own stocks, 75% own ETFs, 73% own mutual funds. So more own ETFs than own mutual funds, and only 6% own cryptocurrencies. I found that very interesting because we tend to think like, oh, everybody's owning a little crypto these days. But it's actually smaller. How is the ETF industry adopting for younger investors? I think the crypto's number there is obviously probably a little bit higher, but like I agree with

you, it's not as high as Robin Hood would make you think. You're dealing with an older investor set at there, so maybe that number is probably right for them. But it's so interesting that the ETF industry adapted during this whole, you know, this COVID phase, these young investors made so much money. They were at home, but you and I have been around a long time. They just roll themselves right into a bull market. Like, who could lose? You know what I mean? They're making 100% on Dividea.

They're making 80% on Apple. So now that gets a little trickier. They're very smart, this young investor base. They start doing options, right? They started hedging. And they don't mind the downside. I don't think the short. Are you sure?

They don't mind the downside? Well, meaning that they're playing the downside, right? Do you think you and I would have had this conversation with a short Kathy Wood ETF five years ago? No way. Nobody would have had the guts to put it out. and nobody would invest in it. I think it's not institutions investing in Sark. It's kids that, like, originally, like, we love Kathy Wood.

And now they're like, well, Kathy Wood's not doing a good job, bro, so maybe they're buying more, as you mentioned on the dip in our previous discussion. But really, they're saying, I love shorting it. I made money on the other side. They really are traitors. It's kind of cynical. They're traders, yeah, but they're traders. That's what's happening, right?

Like, we like her and now we don't like her. We weren't traders. Like, we grew up with a certain amount of, here's what my dad told me to do so I can play with a little bit of money, but I'm going to be in Vanguard and I shares, and I'm going to, you know, make money over the long run. I bet you these 20-year-olds don't want to go near a Vanguard product because they've had so much success in the last two years. So what happens if that stops?

I mean, we have noted for a year now. We're going to lose. The S&P has been up 15% a year for the last 12 years. The average gain is 9 or 10%. So 9% or 10% is big difference with 15%. What happens now if we go to a period of underperformance instead of outperforming? This is their lesson, right? They're learning a lesson.

I think I learned a lesson in the general. dot-com boom, right? I was not quite in finance yet, and I had all these stocks, and boom, you know, down they go. I think they're learning their lesson, but I also think that goes to the stat bob of them being more in ETFs. I think they say, hey, single stocks are hard, I need to maintain exposure, and then you have companies like Defiance, which we can talk about, right, their theme is investing for the next generation, right? And they're not coming out with a... And what are they offering that thing is so enticing? Well, they're not offering the, they're not offering dividend weighted S&P 500.

They're not offering equal weight. They're offering quantum. They're offering 5G. So an ETF and all the FNG is all the 5G products. QTube's quantum computing, right? I don't even know what quantum computing is, you know, but I bet you some of these other kids do. And then you have crews, which they literally launched an ETF

for the resurgence of the travel industry. And we mentioned, I was just at Park City. I've never seen it busy. Yeah. I agree. Defiance is a very interesting company. We've had one. I think the problem here is getting those 20 million Robin Hood users to stick around in a downturn. And you can hear it already.

Throw up your hand say, oh, it's all raped. You know, dark evil forces, the Illuminati. The mean stocks. The hedge fund traders. You know, the high frequency traders, whatever, you know, you think is actually really running the market, your dark conspiracy. There's tons of them out there. Yeah. So what I hope is that those young people stick around for the long run.

And I do hope they start putting more money into the ETFs long term, lock it up. And it's not as interesting. And you have to admit, there's a difference between 1999, that first wave of day traders and 2022. Back then, you couldn't sit on a cell phone in a bar, you know, with your girlfriend or boyfriend and trade. It was pretty cumbersome. Remember those old DLJ accounts they had? It took a while. And it took anywhere from 20 minutes to the next day to get a confirmation.

Yeah. Remember that? It's a very different world. Essentially gambling on stocks and gambling on sports is pretty much the same thing. You're on Draft Kings, you know, and you're on Robin Hood. And to them it's almost the same thing. Yeah, I've never withheld that. You know, I've always spoken about you are entering a casino, you know, when you open your E-Trade account because of the allure of the quick money and they're making that.

I do think, though, and I've seen three of these cycles, right? The up to the 08 cycle and the dot com in my life, and now this one, let's say the COVID one, the three bull markets, which all ended. You know, at some point this one now has ended. There's just more option trading. They understand hedging way more. I just, you know, they just weren't doing the option trading. The option trading is risky. It could be considered more risky, but it does teach you to play both sides of the market, and it does also teach you to hedge.

Yeah, definitely. I mean, the videos during COVID was a major thing. I mean, we talked to Schwab and the Ameritrade people, and their videos went through the roof. They're learning videos on options, went through the roof. So I definitely think that's a fact. And the Nigerian brothers. Look how busy they are with their options strategy. They appeal to the retail. They're doing shows in Vegas, right? They got a business doing it. God bless them.

All right, folks, that's it. And I want to thank Andrew McCormon from Wallach Beth coming by to chat with us. again and just a couple weeks folks by the way we'll be at that big ETF conference in Miami Beach with the top guests there and we'll be chatting with them I'll give you more on that next week everybody thank you for watching the ETF Edge podcast Invesco QQ believes new innovations create new opportunities become an agent of innovation Invesco QQQ Invesco Distributors Inc