ETF Edge - Market mis-match: why it's different this decade 7/5/23

Episode Date: July 5, 2023

ETF Edge dives into the seeming mis-match between continuing calls for a recession... but an increase in investors chasing recent performance in various already-high-flying sectors. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge Podcast is sponsored by InvescoQQQQ, 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, and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll discuss the ETF trade in the second half of the year. Despite a strong first half performance for the broad.

equity markets, ETF equity flows, have been subpar this year. The big money has gone into treasury ETFs and money market funds. Even technology ETFs have seen outflows. So what might work in the second half? Here's my conversation with Todd Sone, ETF and technical strategist as strategist research, along with Dave Naughting, Financial Futurist, Adventify. Todd, all the money in the first half has gone into treasuries and money market funds. I don't know if we can put up this full screen,

But the technology sector is up 30%. But there's been outflows. This is amazing to me. Somebody is really behind the eight ball here. Outflows from energy and value equity ETS. How do you explain this lack of enthusiasm for equities? Just utter disbelief that we've entered a new bull market, a new cycle higher, right? You talk about back at the October lows.

And even through the fourth quarter and first quarter of this year, investors were worried about inflation becoming on anchor. They were worried about it recession, perhaps sometime this year. everyone was happy with 5% yields. Any sort of conversation you had was about, oh, I can get 5%, I'm good to go now. That is until stocks had a fantastic first. Yeah, but they're not good to go. I mean, the real returns have not been that great in bonds. You know, Dave, way in here. I mean, how long are investors going to cling to their 5% money market funds? When inflation adjusted, it's not doing that great. And also when we see the NASDAQ 100 up, what is it, 39% this year? The S&P is up 16%. The largest bond fund, I looked at age

It was up 2.5%. And that's all in. So somebody's got to be getting some FOMO this year. No, I keep waiting for this to happen. Well, we've started to see some of that. I mean, we talk about equity flows being inemic. It's $127 billion so far this year out of 222. So equities have come back a little bit in terms of flow. But when you look at where it's going into equities, it's still playing defense, right? It's quality, it's income. And it's big, large cap, like BTI, S&P 500, VO, SPI. That's not money that's chasing growth returns. Despite the fact, as you point out, this has been an incredible year for growth equity. And it's been an incredible year for niche corners of the market. I mean, we've got to point out that things like GBTC are up 50% this year because of what's been going on in Bitcoin. So there are opportunities to make outsize gains here.

Most financial advisors are still playing defense, though. Yeah, I guess that's what's amazing. I want to talk about Bitcoin in a minute, but I want to stay on equities right now. So I want to talk about the catch-up trade, the FOMO trade. I keep waiting for it to happen. Maybe it won't, but I'm going to stick on it, okay, because it's my show. So you and I, we've talked about this, what might work and might not work in the second half of the year. But it kind of depends on your point of view, right?

So let me hit you with some things and ask you where they might go here. If you believe the market's going to broaden out to include sectors other than technology, what do you like? I know you've talked about the RSP in the past, the equal weight ETF. Why would you like that? Why would that make sense? If you're looking for non-tech exposure and for the market to broaden out, RSP's great, it's equal-weighted S&P 500, everything's on level ground, or VXF.

I think this is an under-radar under-the-radar fund. It's a Vanguard extended market ETF. It's everything but the S&P-500. It's a lot of smid-cap exposure. Small and mid-cap. Exactly. Another great way to. to judge market participation.

If you're looking for the cash of trading, those are your two best best right there. I'm going to hit you on a couple other points. Dave, of course, weigh in any time you feel that you want to add something here. But how about inflation? Go ahead, Dave. I was just going to say, if I was going to pick two, I think advisors have this right. I think playing a little bit defensive this rest of this year as opposed to trying to chase tech is probably the way to go.

I like things like JP Morgan's Equity Income ETF, the largest active management fund in the world right now for ETFs, JEPI. That's been a huge flow gather. It's delivered for investors. And I got to agree, I think something like extended market or equal weight exposure is a great way to try to leg back in if you've missed that rally so far this year. Okay. How about inflation? I get notes all the time for people who think inflation's not going away. So if you think inflation, it's still going to be an issue, but you have to, you want to stay in stocks. I assume you like there's a fidelity stocks for inflation ETF. This tracks an index of a lot. large and mid-cap companies that are tilted towards inflation-sensitive sector.

Yeah, if you're worried about an event happening and inflation becomes unanchored, right, I know we've been decelerating here globally, which is great. But if you just want some protection by the FCPI, that's a basket that all these should protect you, should things start to turn up again. There's other options out there, INFL, and it's an inflation beneficiary's ETF. I would watch the relative performance here. They have deteriorated, which should suggest that inflation maybe does not become an issue again. But just in case you're worried about that, or you have clients, we're worried about that.

That's the way to go. We have three big IPOs last week, and the IPO market's starting to look like it's open, not quite. So this is an interesting play, because if you think the broad market rally is going to continue, IPOs should do well. The Renaissance Capital IPO ETF, this is a basket of the last 50 or 60 recent IPOs. They're up 35% this year. That's twice the S&P performance of the S&P. I like it as a risk barometer.

If this fund continues to act, well, that suggests to me it's risk on still for the markets. And also keep in mind, I don't know the exact decline, but you're probably in the 70% drawdown from the peak in 2021, along with other growth plays. So this is still very much in recovery mode. Yeah. And it's a good first half, but I think there's a lot more. Amazing thing about this, Dave, the Renaissance Capital IPO, which I tracked very carefully, is it's theoretically 50 or 60, the most recent IPO.

But the most recent ones were like three years ago. So there's stuff like Snowflake that's from, you know, 2020 here. Not that there's anything wrong with that, but it's a little long in the tooth, some of these for IPOs. I agree. But I think that this is a really interesting window to think about getting into IPOs. Think about it. If you're a small private company and you're trying to continue operations, historically you've had two sources. You've been able to go get debt, maybe from your venture capitalist, maybe from a bank,

or you've gone to the market and done an IPO. In a higher interest rate market, going IPO all of a sudden looks even more attractive than it might have already. And obviously, as you point out, with 30% run in the NASDAQ already, which is a pretty decent proxy for new IPOs, it's real tough to argue this is a bad time to make an IPO out there. It's been so long. I think there's pent up demand, not just from the index funds like this, but from just the rank and file institutional investor. We keep waiting. I keep the cynics out there, and there's a lot of them about this IPO play, keep saying, well, wait, will the run.

Reddits come or the Fogo de Chowse or some of the armed big semiconductor, you know, chip manufacturer or design manufacturer. And it's true they haven't come. The big names haven't come. But we are slowly opening up. Another one I get a lot of cynical comments about is the AI. Of course, we all know AI has sort of driven a lot of the tech gains in the first half of the year. So what if you play against this? You think the AI thing keeps going in the second half? There's a bunch of the ETFs around this, the Roundhill generative AI and tech ETF. The symbols chat. I like that.

And that's the usual names in this, Nvidia, Microsoft, Alphabet. So a great trigger, number one. What I like about this fund compared to others is that it's actively managed. So the folks at Roundhill, they can do their research. And if a company decides, you know, we're going to pull back on AI, or we're going to get more in-depth on AI, they can manage that, as opposed to an index that may have to wait for its rules to settle in, whether it's quarterly or similarly annually. So I like the chat play. Of course, there's other products that have been around for some time, but this would be my preferred route if you want to get that AI exposure

and see how real the demand is. Is it silly to keep chasing this AI story, Dave, given the ridiculous run-ups and Vyndi and the Picks and Shovel story? I think it's not a pure play. We run into this all the time, Bob, when we have some cool new technology, and then we look at the see how we can play it, and we end up buying Google and Microsoft and Apple and Nvidia,

which we all over. own probably too much of. I think AI is here to stay. I think it's going to have a long-term and significant positive effect on GDP. I think it's very difficult to pick public companies that are going to be the outsized beneficiaries of that. I actually think looking at industrials and robotics and automation is probably where you see those economic impacts hit, but it's going to be a whole lot less sexy than buying something that says chat on the front. Yeah, it's a narrow field. We've always had this problem. We had this problem with poverty. stocks, by the, there's nothing to buy, essentially. We had this problem with Bitcoin,

then there was really nothing to buy. AI, at least you have a much wider field that's actually out there at this point. But he is right. I mean, it's a fairly narrow field. To Dave's point, BOTZ, which is a robotics and AI fund, has a lot more industrial's exposure than your typical AI fund that maybe it's from Chad or a little fun from Wisdom Street. So I like that route, too, that Dave mentioned, if you wanted to get away from tech, because you already have tech exposure in your portfolio, you know, the industrials are a beneficiary too. Yeah. And by the way, as much as we'd like to make fun of this, that trade worked this year.

And so did the AI play very much worked here. So the only question is whether it continues. How about commercial real estate? What if let's play against the tropey? Do you think the commercial real estate sell-off, it's been pretty noticeable, particularly in REITS, is overdone. What do you like here? DCMB, that's the Double Line Commercial Real Estate Fund. It's new, relatively last quarter or so.

It's from the Jeff Gunlock team, right? I think if you are trying to take a contrarium play, that commercial real estate isn't going to fall apart, this is the place to go. Why would Double Line launch a fund in commercial real estate right into the heat of the moment here? I think they see an opportunity. I think if you want exposure to that corner

in a slice of your portfolio, this is a way to play too. And this is commercial mortgage-backed securities too. Yeah. Remember, these are not necessarily properties here. These are commercial mortgage back. You're getting a little more exotic than just buying a plain vanilla refund that may have office recent or something like that. Yeah. So, which I do like.

And I think, yeah, if you're going to go with something that's contrarian like investing in real estate right now, I think this is one of those cases. You want somebody mining the store, right? So having an actively managed approach where you've got seasoned real estate folks making security selection decisions, if you're going to be a contrarian, get some help. Yeah, I would agree with that. In this kind of situation, and I agreed with that, as you know, I'm a passive guy, but active management, I thought, did very well when the bond market was moving around like crazy. Those are the kind of situations when things are moving fast, active management can really, I think, help. Dave, I want to switch the subject up.

Bring us up to date on the Bitcoin ETF filing. So we talked about this. Don't laugh. I have you here because that's why you're here. We did this last week. We had the BlackRock and Fidelity's now, jumping in. So handicap this one for us. Will this one get to go ahead? And if so, why? What would take it over the top? Well, everybody refiled, depending on how you read the paperwork, most of them

refiled on Friday. Some of them claimed to have refiled a little bit earlier. All of them are now talking about having a surveillance sharing agreement with Coinbase, the largest, you know, Bitcoin USD dealer in the world, largest Bitcoin exchange in the United States. And I think there's this idea that somehow BlackRock knew something and that the SEC is on the verge of proving this once these surveillance sharing agreements are in place. I'm still fairly negative on this. I think we've reset the clocks here. It actually puts ARC and 21 shares out ahead if they followed the letter of the filings. But I think what's most likely to happen is we're going to get a response from the SEC that says new filings and SSAs have to look like this.

everybody please refile by X date and then they'll make a decision. I think it's unlikely that they simply anoint a single winner and say, hey, BlackRock, you get to go out to market a week before everybody else. We all know what that looks like in this market being first really, really does matter, especially if first comes under the umbrella of somebody like an I-share's BlackRock. So I think the odds are still negative for this year, but certainly things look more positive than they did maybe three weeks ago, six weeks ago. I would certainly agree that they're not going to approve Black Rock suddenly and ignore everybody else. That would create a real how. But I think the real question is, what's different here? Do you think this surveillance agreement, this Coinbase Surveillance Agreement,

really is enough to satisfy their objections about fraud, custody issues, and all of those things? Is that by itself going to do it? It shouldn't be. Based on what they've said before, the words out of their own mouth, not just about Bitcoin, but about other markets where they've established surveillance sharing agreements, there's a level of scrutiny that's involved that I will be surprised if Coinbase can meet the mark on. However, if what's really going on is the SEC is looking for a get-out-a-gill-free card, they know they're going to lose or think they're going to lose the Grayscale lawsuit, they're looking for a way to say something positive about all this. If they're trying to manufacture a way to approve a Bitcoin ETF, this would be the way to do it.

It would still be a big shift from what they've said in the past. You have written, Dave, and implied that Grayscale might actually have a chance at winning. Why would they have a chance at winning? And I would agree if they have made a calculation they might lose. This might be a back-door way to sort of smooth things over. But why do you think Grayscale has a good chance of winning? Well, if you actually dig through the case as an impartial observer and you look at the facts being presented to judges, three judges in this case, I think it's quite reasonable to say that the SEC has been arbitrary and capricious and how they've applied certain rules. Now, that doesn't mean that they necessarily approve the conversion of GBCT to in that ETF, but I think they can still lose that lawsuit that says, hey, you've treated somebody unfairly under the administrative product, that Procedures Act.

So that's a real case for them to lose. It doesn't necessarily mean they flip the switch and all of a sudden this trading is an ETF. That's a much more complex process. Yeah. I must say I have a problem with this argument that they approved a Bitcoin futures ETF. Therefore, they must approve it, a spot Bitcoin. In a futures product, you have a closed ecosphere, essentially. You have positions.

You have long and short that can be easily monitored. And you don't have that in the Bitcoin ETF. the spot Bitcoin situation. So there's a difference here, it seems to me, even if you can make an underlying argument, well, if there's fraud in a spot Bitcoin, they would imply there'd be fraud. Do you get my point here? I'm not sure that it's the same argument. It's actually sort of backwards. When they originally rejected some of the filings back in 2018, what the SEC said was historically when we've approved commodities spot products, there has been both a spot market and a big futures market, and the combination of those two is what gave them solace to approve

those products. But then they went ahead and improved the futures product and not the commodities spot product. So they've sort of talked out of both sides of their mouth on this. I think it's unlikely that they're going to win largely because of details in the case. I agree with you. There are different markets, and it's actually, I think, reasonable to say you can trade futures, but you can't trade spot. We say that about oil. and nobody has any questions about it, right? Because they're mechanics of the oil market that don't let you do this.

The mechanics of the Bitcoin market are much more like gold, and therefore it's much easier to do. Storage is trivial compared to oil, but I think it's still likely they're going to lose. I want to ask about a survey moving on here, thanks for your input on that, about RIAs and advisors,

because that's the heart of this whole ETF game and VETify you guys regularly go out and survey advisors. You're very much on top of, of what the advisor, RIA community, and you had an interesting survey out. I want you to share this with us. What percentage of your portfolio is allocated to ETF? It's a pretty simple question.

I was surprised at the answers. It says here about half of the advisors are using ETFs for more than 25% of their portfolio. I guess you call them power users, die-hards, whatever. But a quarter are still dabbling. They only have 10 to 25% of their portfolio in ETS. ETFs and a quarter have 10% or less. Is this a little surprising you, Dave? I would have thought RIAs would be using ETFs much more heavily just because they're

just so much more cost effective. They're cheaper for clients. You can still charge reasonable fees. I don't know. Or maybe am I wrong? How am I supposed to read this data? No, no, no. I think we have to keep in mind that when an RIA is dealing with a wealthy family, right,

There's a portion of the portfolio that we think of as their portfolio, their investable market portfolio, stocks, bonds, ETFs, mutual funds. But remember, they're also dealing with cash management. They're also dealing with real estate and trusts and retirement accounts. And in those cases, things like their client's retirement accounts, trust money, those may be allocated into private funds. They may be allocated into mutual funds. As we well know, the 401K market is still massively dominated by traditional mutual funds.

So I don't find it that surprising. I think it's interesting to me that there's basically. basically nobody not using ETFs. It's just a question of how far along on that adoption curve they are. We've been asking this question at VETIify now for years in our predecessor companies, and I will tell you, that number of people who are in the 25% mark goes up year after year after year. So I don't think we're ever going to end up in a world where it's 100%, but I think we're rapidly approaching a world where half of most advised portfolios are in ETFs. Yeah, that makes some sense to me. I mean, what you're saying, on 401Ks make sure.

a lot of sense. I tend to talk to the RRA community that's most actively involved. The old guys who left Morgan Stanley and Merrill Lynch to set up their own shops and those people with the clients they're taking tend to be using ETF. So there's a sort of self-selection process that's happening with me. But your point on 401ks make a lot of sense. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Dave Nautic from VETA-Fi. Dave, thanks for sticking around.

I'm still amazed, and I know I talked to Todd about this briefly in the show, how, as you say, flows have not followed performance. Technology is up 35 percent, the technology S&P, and yet there have been outflows from tech this year. Why, there's a serious mismatch here. There's some serious fomo going on. Somebody's got this very, very wrong, but it's unusual. to see how wrong it is. Usually by now, when you have big momentum in, say, technology,

people start piling in. You don't have a whole half a year go by, and a lot of people have missed the boat. What do you think is going on? Well, I mean, you know, there is one alternative here, which is that people could be right this time. Usually people are coming in and chasing performance, and then we all lament that, and we say, well, look, this billion dollars showed up just as tech was about to crash. It's certainly possible that we're going to look back in a quarter and be like, gosh, the flows were smart this time. But your point is well taken. Historically, advisors chase performance, investors chase performance, everybody chases performance. This time, that seems not to be the case. So there are a couple of ways to think about that. One is we really have reset the investing

playing field because we have a live rates market and we have liquid alts that are available. So people are really looking at all of their alternatives, pardon the pun, in a way that perhaps they haven't for the last decade when we haven't had a live rates market. So that's certainly one thing that we've had a de-equitization of portfolios because fixed income is now relevant again. But I think the other thing is that while we've had this run in the market, the sentiment has never really come around the way we would expect. There's not very many folks out there calling for a raging three-year bulls. market beginning of a new super cycle. There's still a lot of folks on the street calling for a recession. There's still a lot of concern about interest rate policy. And there's a lot of concern about this election. So there's lots to be nervous about. It's not super surprising to see tech

coming off the table. Yeah. This whole thing happened with the analysts community too. Remember the end of last year, everyone was screaming, well, going to have a recession. And why aren't the analysts dropping their estimates for 20, 23 earnings? Because a lot of the top-down strategists had estimates down 10 to 20% for earnings. And it turns out the analysts sort of stuck not doing anything because the companies don't tell them to do anything have been right so far. We have not had an earnings apocalypse at all. We had the SMB dropped 20%, but we didn't have a big drop in earnings expectations.

So the cautious analysts so far have been right this year. I'm getting to your point out here about maybe some people are right long term. Yeah, I think the other thing that has been, it's been certainly covered on earnings, but I think has maybe not quite landed in the investor, Zykeist with authority, which is the reason we didn't have an earnings apocalypse is because the vast majority of companies were able to increment price over the amount of inflation in their supply lines, right? So price over volume has been the story of the last two quarters. You know, we can call it greedflation.

You can call it, you know, positioning, for future supply chain disruption, whatever it is, companies were able to charge substantially more than everybody thought they would get away with. And that has kept the equity markets healthier than they might have been otherwise. I think it's reasonable to suspect that that is not going to be the case. I don't think you're going to see P&G passing on 10% across the board

price increases like they were able to do over the last year. Yeah, that's certainly a problem. Let me ask you about active versus personal. I'm sorry, active versus passive, there are continuing to see some inflows into active ETFs, but I wonder if this is a little bit overblown. What I see is active ETFs continue to gain ground, but it's usually, it seems to me, at the expense of active mutual funds. It's not at the expense of passive, people taking money out of passive and putting it into

active, it's active mutual funds converting to an ETF structure or people taking money out of active mutual funds and putting into active ETFs. Is that fair directionally or give me some feedback on that? It's absolutely fair directionally. We won't know the full first half mutual fund numbers, but we're probably on track for 100 billion or so of outflow from active equity mutual funds in the first half. Meanwhile, we've had $33 billion in positive flow on the, on the, the, on the, the, side of the balance sheet. I should point out it slowed down. The first quarter of this year was just active, active, active. It was almost all fixed income, and most of that fixed income was, in fact, actively managed. What was coming in on equity was going into ARC and JEPI, the two funds

that have really been the story on the active equity side. That's really slowed down. If we look for the full six months, we've had about $33 billion in active flow out of $222 billion overall. That puts it at something like 13, 14%, that's about on par with where we were all of last year. So we're not in this realm again where we've had this huge flood of active. I think we've normalized back to a zone where we're going to get 15, 20 percent of all the flows into active strategies. And I think increasingly that's going to be on both sides of the balance sheet, not just fixed income, which is where it's historically been. You mentioned ARC and JEPI. Arks had outflows this year, I believe, right? I mean, despite, you know, a great year.

Surprisingly few. Surprisingly few. Yeah. JEPI, you know, I know it was the big winner. It was, you know, an ETF for the year last year, arguably, had huge inflows. And yet, you see the downside of when you're in up market here, you give up a lot when you have something like Jetpy, right? Yeah. I mean, I'm sure that J.P. Morgan's still pretty happy about their $10 billion in flows this year so far. But yeah, there's no question that these heavily income-oriented portfolios are, in fact,

vulnerable to being oversold, right? I mean, somebody asked me the other day, if everybody's selling volatility, at some point it gets too cheap to be worth selling anymore. And that, I think, does have a bit of an issue here. That being said, I talked to advisors who are still focused on defensive equity, equity income, buffered products. They're still trying to hedge that downside. there are a lot of advisors out there

who think there's still more shoes to drop. There were a couple of buffered products introduced last week, right? Yeah, I mean, at this point, I mean, Black Rock's in the game now. Pretty much, you know, if you're going to be a full-line product offer, you're going to have to have some sort of buffered product

in the suite. Yeah, people want it. It's certainly understandable. Although you see in an up year like this, you give up a lot just to have those buffered products. Dave, thank you very much for joining us. Dave Nauging is the VETify Financial Futurist. And thank you, everyone,

for listening to the ETF Edge Podcast. InvescoQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQ, Invesco Distributors, Inc.