ETF Edge - Regional Bank Fallout: The Flowdown for May 5/3/23

Episode Date: May 3, 2023

:CNBC’s Bob Pisani spoke with Reggie Browne, Principal of GTS, and Kevin Simpson, portfolio manager at Capital Wealth Planning. They discussed the fallout from the regional banking meltdown. No surprise short positions are on the rise, but what about bank ETF flows? Our panel of experts broke down where the money is headed in this ever-changing market landscape, and offered their takes on other pivotal trends like dividend income ETFs both here and abroad – as well as covered call ETFs strategy, which has steadily been gaining steam. In the “Markets 102” portion, Bob continued the conversation with Reggie Browne from GTS.   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 Fazzani. Today on the show, ETF Edge, we will discuss the fallout in the regional banking meltdown. No surprise, short positions are on the rise, but what about bank ETF inflows and outflows?

Our panel of experts break down where the money is headed in this ever-changing market landscape and offer their takes on other pivotal trends like dividend income ETFs, both here and abroad, as well as covered call ETF strategies, which has steadily been gaining influence. Here's my conversation with Reggie Brown, the principal at GTS, along with Kevin Simpson. He's the portfolio manager at Capital Wealth Planning. Reggie, good to see you, as always. The S&P financial ETF is down 5% this year. But if you look past that, you look at the basket of the KBE,

which is Money Center Banks and Regional Banks, down 24%. The Regional Bank ETF, KRE, down 32%. Sort this out for us. What's going on? Well, KRE is net losing assets. If you look at the entire suite of regional bank ETF, They're picking up assets. I think a lot of it is two drivers.

One, valued players coming in to buy. KBWB is a VESCO ETF is one of them. Pick up a ton of assets over the last three weeks. But also I think there's a bunch of short sellers in the marketplace that are looking to borrow shares, and thus creations go up. And shares outstanding go up. So I think it's a two-sided equation here. Yeah, it's a little confusing for people.

So these regional bank shares are dropping fast. But as you mentioned, there have been notable inflows into the regional bank ETF, KRE. Shares are being created. That's an equal weight basket of the large regional banks. So the inflow, the shares are being created because why? Short sellers are piling in and the market makers are having to create new shares to account for these short sellers who want to sell this. Exactly.

Listen, ETS are dynamic. And what's under the hood is very important here. and as you say, the individual stocks are dropping fast, but all of them are not in trouble or have problems with their balance sheet. And I think the sector is probably in focus for advisors start piling in in certain areas. Yeah, Kevin, any thoughts on the banking situation? The current concerns are, as I said, it seems like it started as a deposit flight worry, but it's a lot broader than that.

They've expanded now. We have hired deposit costs in general as an issue. There's the prospects for more regulation for these regional banks. And most importantly, as I mentioned, these credit issues, specifically around commercial real estate down the road. Well, yeah, I think you hit the nail on the head, Bob. But the one I'd be most concerned about of the regulatory issues because that's a given.

And it's not going to be isolated just to the small banks or the regional banks. It's going to affect banking in general. And from that lens, you have to assume that earnings are going to come down a little bit across the board, much more so, I think, with regionals and super-reaching. than with the major banks. But in the ETF, we manage in Devo, we own J.P. Morgan and we own Goldman Sachs. And certainly to the extent that we've seen deposits going to J.P. Morgan, I think that's been a strong positive development. But we can't ignore the commercial market that you mentioned. And I think, again, just to restate it, I think the regulatory issues are

going to be the big across-the-board problem. Yeah. Now, you mentioned Devo. Let me bring that in here. you run, this is a slightly different issue, but you run the Amplify Enhanced Dividend income ETF, the symbol is Divo, DIVO. It's an actively managed ETF. It provides income by, it select stocks with the S&B 500 index, and you overlay it with a call writing strategy, essentially. And this goes long with a, you know, a kicker. This was a big hit in 2022.

Explain for people who don't understand how these things work, what Devo does. Well, I'm only going to speak on Devo, because, When we talk about option strategies, you can get a lot of wonky and get into the weeds. But for us, we like to keep it simple. We own 25 to 30 best-of-breed blue chip stocks. I know best-of-breed is somewhat relative, but we allocate across all sectors, Bob. So we're looking for companies that simple. They make money and they distribute cash flow to shareholders.

So we're looking for companies that pay dividends, but really more than that, we want strong, powerful dividend growth. And I think that's more than anything, the few. fuel that feeds our engine. The covered call piece is implemented as a means of harvesting volatility to protect a little bit of the downside. And we tactically sprinkle in some short-term out-of-the-money-covered calls. But to your point, from a popularity standpoint, when interest rates were very low and we sat on a near-zero interest base for a very long time, over a decade, anything that you could

do to enhance cash flow became very popular. You saw a lot of strategies pop up that really tried to pump up the yield. is a modest cash flow. We shoot for four to seven percent, much of that coming from dividends. And really, it's a risk-adjusted total return strategy. Right. So these covered call strategies were kind of hugely popular last year. And I guess it's great. You collect some income, and that's how you kind of outperform. But the downside is it's great in a side downways, down market. But if the market keeps rising, you're essentially giving up upside, right? Because you're selling the covered calls.

Yeah, admittedly, when you introduce cover calls to a strategy, you're going to be forfeiting some of the upside. And when we look at Devo, we're thinking about how can we capture 80 to 90% of the rising market and limit the drawdown and the participation in the down market to 65% or 75% by tactically looking at covered calls. And literally, we get criticized for being frugal on the option writing at times, but what we're looking for is we want to participate in rising markets, dialed back on the option writing, and then when you have volatility, kind of put the pressure down,

take advantage of it. Cover calls work best when you need them to most, Bob, and periods of higher volatility. Yeah. And you also run an international version of Devo, IDVO. And you own some big names in here. You own PetraBos, for example, the Brazilian Energy Company, which is similar to Exxon, but I gather you think it's significantly less cheaper with a big dividend. What is it, what is the It's like 20% now. It's crazy, right? I don't even believe. I mean, literally, I look at it. I send it to you in the notes, and I'm like, how is this even possible?

But they've been increasing this dividend at a very rapid clip over the past five years. It trades with a three multiple. Like, no joke. And the dividends close to 20%. They have to be careful with international stocks. I mean, these aren't, it's not ex-stop. And there are lots of variables that go into it. And they raise their dividends and lower them.

I mean, it's not a stagnant dividend by any means with any of these companies. That's a heck of a yield, huh? Yeah, and I know it's crazy, but it went ex-dividend just recently. And you also own 10 cent, the China Communication Company. It's a lot like Google here, but again, it's cheaper. What is it, 14, 15 times PE. This is why a lot of people like China as a value play. Yields are about 4%.

It's been growing 25% in the last three years. I don't know what the sales growth is. It's over 10%, I guess. And cash flow earnings is over 20%. So I get the value play here. If you believe what they tell us, you know, it's coming out of China. So you take it with a grain of salt. But our theme in this international play, Bob, is that the second half of the year is a China reopening story for international names.

If the dollar levels off, and that's kind of a thesis we have where it's outperformed for 12 years. And it doesn't have to pull back. It just has to level off. And then you also look at the fact that some of these international stocks specifically might be more attractive. than American stocks when you think of a Chinese consumer. But that's a conversation for Lake. Yeah. Reggie, any thoughts on the popularity? These covered call ETFs?

They were just a huge hit last year. And like I said, sideways down market, they're great, but you're giving up something. Well, first of all, they're complex. So it's pretty important for advisors and retail mom and pop to understand what they're buying into. On the whiteboard, there are a number of strategies to come into the marketplace. I think they fit a purpose, and they've worked remarkably well. Bruce Bond was first to introduce a cover called Buffer Strategy under his lineup and then bring competition to marketplace and drop fees down significantly.

So I think there's a lot of opportunity to bring innovation and value to a segment of the population around covered calls and input strategies and they're coming. So yes, they're complex. It's really important to understand how they're built, how to use them, but there's a purpose for them. Yeah. I want to go back to the bank story because the viewers. are really sort of confused about this. And one of the key points that I always point out,

and bank analysts are pointing out is banks have not been very good returns on investment for a long time. I was at a conference yesterday, a charity event. One bank analyst said to me, the owners of bank stocks are asking, why am I here to begin with? You know, and he meant by that, a lot of investors have not been compensated for owning bank stocks or bank ETFs for many years. as we bring up this regional bank ETF, the KRE, it began trading in mid-2006. But look at these numbers here. Since its inception, it's down 20%. Down in 17 years, it's down 20%.

And these banks have never really recovered from the great financial crisis. And since then, as you see here, the S&P 500 is up 230%. These are like airline stocks. They're like heartbreakers for years and years and years. So it's not like this particular crisis suddenly destroyed a super investment opportunity for people. Listen, banks are essential to American economy. And so for investors to lend capital to them for their operations for return to capital, look, they're great dividend payers.

Look at Apple. They just introduced a savings account. They got a billion dollars reported in a short period of time, over 240,000 accounts paying 4%. And I've read this all in a newspaper. I'm not close to them. And so if you look at the demand for a yield, banks provide a service. But as far as the composition, it's risk adjusted. best to make their decisions. You know, that's a very good point about the dividends because we tend to put these up, but we make this mistake with the S&P 500.

We don't include total return. That's correct. And that is a very serious error, because as you know, just in the S&P 500, if you go back 20 or 30 years, it's a significant component dividend of total return. So if you get a bank stock that's doing 3% a year and you compound that interest over time,

you may get a much better return. Well, the dividend yield, SP 500, is around 1,7,878 basis points or 2%. So if you're longed to SB 500, you get your 230 basis points of returns plus dividends, it's pretty significant. Yeah. Kevin, we are in the middle of earnings season right now,

and it's been kind of strange. They were dropping estimates rather dramatically going in. In the last couple weeks, as we're in the heart of earnings season, the numbers are coming in much better than expected. So the estimates for the first quarter are now actually going up again. And in the second half of the year, they're fairly stable.

So while there's an earnings slowdown, there's certainly no recession and earnings recession going on. In a real earnings recession, you know, this earnings will go down 10, 20, 25%. We're basically flat for the year on expectations for the S&P 500. Any thoughts on what this earnings season is telling you and what you're telling your clients? Yeah, I mean, when we look at the earnings, the earnings beats don't mean what they used to in the old days. because we know where the bar gets set. We've got to do everything we can to beat it or at least come close to expectation.

So what I'm listening for on every single earnings call is what the folks are saying about the rest of the year. And we're not seeing material increases on the rest of the year. Not to your point, Bob, we're also not seeing the drop off, which is a good positive sign. But what I'm hearing consistently

is that companies are reducing expenses and they're reducing investments. So if they're planning for a slowing economy, I think we really need to pay attention to that. because there's there's consumer spending business spending and government spending and and I think what we're seeing this particular earning season is the yellow light the businesses are tightening the belt just a little bit and again that's not a precursor to a recession it doesn't have to happen that's what I'm here and I wonder if you can comment on the overall trading situation and

the situation with with the VIX so you're at GTS is one of the biggest market makers in the world you see an awful lot of flow one of the things is striking to me is the volume volumes can be very light on certain days, considering how edgy things are. And the VIX is remarkably sitting with 16, 17, I think it's 18 today. But historically, the VIX is 20, 21, 22. If it gets up 28, people start paying attention. But when it gets down to 16, that's sort of remarkable. From your position at GTS, how do you account for the somewhat lower trading volumes

that are sort of expected in certain areas and volatility being so low, all the anxiety that's out there? Well, I think even another measure, there's a new measure around one-day VIX, and that's even lower. There's no fear in the marketplace. I think all information is in the marketplace, and advisors and retail players have a good understanding about what to expect, and they're watching this one sector. I think there's no fear.

The overall ETF industry this year-to-date has accumulated over 700 billion of new assets, and you're seeing just people piling in into ETFs, like I-Shares-Qaeda. and then the SP500 complex across the board. But look at Europe. Europe is up 12% in year today. I know, I want to talk about that later. It's just, you're just seeing just pockets of opportunity. And I think that with the marketplace, there's no particular fear.

And so there's not a lot of trading frequency because long inland is fine. The viewers seem very confused about the VIX. They keep saying, how could it be at 16? That's really, you know, that's a new low. And why are people so complacent? Why aren't they more fearful? Don't they know there was a recession? But the VIX, you know, we point out the simple fact, it's only a 30-day indicator.

That's correct. The one that we use. If there is a big event 31 days out, it will not show up in the VIX. And you have to explain that to people because it's not a recession indicator. It's not in anything. It's just an expectation of volatility in the next 30 days. And if they don't think there's going to be a big event in the next 30 days is going to alter what's going to happen, it will not be, it will reflect that.

Beyond that, it won't reflect anything. It's not measuring anything beyond that. But that's indexed fault. If you look at individual company volatility in some of the bankers, bank sectors. Oh, yeah, huge. The volatility is north of 100. You know, if you look at somebody's individual names. Oh, yeah.

And it's even tough as a marketmaker to sell into that, into that because it's illiquid to get out. And so I think that overall, yes, volatile is low. Individual names, not the case. Yeah. We've seen trading volumes in the regional banks, five, six, seven, eight, nine times historic norms on a daily basis. Banks trade three million shares a day, trading 20 million, 24 million shares a day.

Enormous. 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 our podcast. We'll be continuing the conversation with Reggie Brown from GTS. And Reggie, you had mentioned in the show,

very interesting inflows and some outflows in ETF's. So handicap this for us. It looks to me like inflows into U.S. equity is flattished to down, and yet I see enormous inflows into international. Europe is getting money. After underperforming for more than a decade, what's going on there? Well, Europe's up 12 percent, and you have people chasing returns,

and you're seeing a lot of money from a European perspective going to European credit ETFs. They're a version of high yield. their version of investment rate. And you know, you can't blame them. And I think you're just seeing a rotation around world country sector rotation. And so out of the U.S. into develop Europe and then emerging market bonds, we're seeing people pecking around looking for value.

It's quite amazing. I mean, in a sense, Europe's underperformed the U.S. for decade, more than a decade. So you do get it. I mean, reversion the mean is a real thing. Sure. So that would make some sense. And yet there were plenty of people six, eight months ago, said, oh, my God, this is going to be a terrible winner. We've got a war going on with Russia invading Ukraine.

And yet, things have happened that are really strong. Now, a lot of people point out that China's reopening, and France has a, you know, a lot of Richmond and LVMH are doing well. But even Spain is up. It was at a new high a week or two ago. Italy was at a new high, the Italy ETF. So it's more than just people buying low. luxury stocks on the back of China reopening. Generally,

the economy's held up better, I think, that people thought. Well, I think post-COVID, re-opening, and the consumer mindset from a European perspective are having re-engaged into putting their money to work. I think you're just seeing that. I think it's post-COVID people come back and they want to get back after it, consuming and buying services.

You know, anything else is always a rotation around the world. If you look at the United States, lots of flows into products, but from a European perspective, the returns are there right now, and people are addressing that. And then the bond market. So last year we had a year, a strange year with stocks down 20% and bonds down. And yet this year, huge inflows into treasury bond ETFs, particularly short-term ones. My mother is pulling money out of her bank account, buying CDs and, you know, one-year treasuries, and flat to outflows for corporate bond ETFs, and generally,

I haven't looked recently, but up through the first quarter, there were outflows from high yield as well. So they got a bifurcation even in the bond market. Well, I think a lot of that was related to financials. I think everyone had reduced their risk to the financial component just because of the uncertainty around just bank balance sheets and what's to come. Anytime you have a move of down 20, 25 percent, and the equity. standpoint, people tend to get conservative a short duration. And then when it was time to leave the markets all together, people look for Treasury like ETFs with a higher yield with a very short duration. They were the winners. What about overall flows? We got very spoiled in the ETF business of expecting 500, 600, 600, 700 billion, 800 billion inflows every year into ETFs, gross inflows. And we were at 7 trillion at one point, maybe fell back last year because the prices were down. But I think everybody in the business got used to the idea of the slow and extra march of ETFs.

Assets under management growing every year. It slowed down a lot this year overall. It's slow, but it's still trickling higher. And I think from a standpoint, you're still seeing people leaving other types of vehicles like mutual funds and go into ETF format. And you're still seeing new managers come in. But it's really about the advisor community putting assets to work. and they're choosing active ETFs to deploy. And if you look at the Capital Group, for example,

they launched into Marketplace, and then they're addressing now with a whole new product set and people have adopted them. So I think that there's pockets of success stories here around asset accumulation, but also the ETF structure, I think, is the winner. So the ETF community in the United States has marched forward with 700 billion of new assets.

So it's not necessarily a story to write up. is just a story about right here, right now, the consumer mindset and how to think about risk. Reggie, thanks very much for joining us. Reggie Brown is a principal at GTS. And thank you, everyone, for listening to the ETF Edge podcast. InvescoQQQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQQ, Invesco Distributors, Inc.