ETF Edge - Summer of love… for ETFs 8/1/24

Episode Date: August 1, 2024

Oceans of money are flowing into ETFs. But where’s is all suddenly coming from and, perhaps more importantly, where’s it all going? Plus, could the election suddenly reverse this tide? 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 Invesco QQQ, proud provider of access to innovation for the last 25 years. 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 Kazani. Oceans of money flowing into ETFs in July. Where is it going?

And where did it come from? Here's my conversation with Matt Bartolini, managing director at State Street Global Advisors, head of Spider-America's research in Troy Donahue, head of America's portfolio trading at BTIG. Matt, you reported $127 billion here in July. That is a record for July, the second largest monthly inflow ever. As I mentioned, we seem to be heading for a trillion dollars of inflows a year. That's a real record as well. What's going on?

Why is all these inflows happen? Yeah, I mean, part of it is just the market. The market continues to move higher, and we see investors deploy cash from the sidelines. A lot of cash was built up over the years. We're starting to see investors really make a concerted effort to continue to buy into this rally. We also saw a sort of broadening the market depth of rotation take place, and that was a signal of more risk-on, vibes going into the marketplace. So small caps do well, set-pacles do well. Equities in general took in $78 billion.

A lot of that was just the U.S. So it was just sort of a lot of concerted efforts to buy into this rally. and then fixed income added another record $38 billion, and a lot of that was driven by credits for another risk-on type of trade going on in the ETF marketplace. And Troy, it sure seems like Goldilocks here for ETFs. I mean, we just put up a full screen here. We've got momentum, ESMP being up about 15 or 16 percent this year.

We've got earnings growth. We've got generally lower rates, certainly trending in that direction. We've got rotation. We've got a reasonably strong economy still. What could derail this in the second half of the year? It's kind of perfect situation. Yeah, it's been a great start to the year. Like you said, could be the first trillion dollar year that the ETF industry has.

And I think investors are kind of waiting to see what's going to go on with the election. It was a little bit more clear a month ago. And now with a few changes that have happened, investors may be hesitant to put more money into the ETF market and the stock market in general until they get a little bit more clarity on that situation. So July, though, I just want to look back, it really was extraordinary, the great rotation that occurred here. It was a month when small and midcaps and value stocks rose in cyclical groups like regional

banks, home builders, industrial rows, these are cyclical. These groups, we haven't had big inflows in these groups in a long, long time. Did we see actually evidence that there was inflows? Was it a noticeable change? The big rotation actually happened in terms of inflows. 100%. So small cap ETFs in the US took in $13 billion. That is the second most ever.

And that flow is backed by returns. So if it's a small relative to large. Small caps, be large caps by 10%. That is the largest differential since 2000 in the third largest overall in the last 46 years. There was a significant rotation into small caps. And investors bought into that. Same thing with cyclicals and value.

Value, while had less flows than growth, the spread between those two narrowed last month. And again, that was supported by strong returns. Value outpaced growth by a significant amount. And we're starting to see this broadening, this broadening of economic growth, this broadening of fundamental growth, and a broadening of sector dispersion, where it's not so heliocentric towards tech. Yeah, so we had inflows into small caps. The second largest inflows of the small caps ever, 11 billion.

We still had inflows into tech, which surprised. me and cyclical sectors had had nice inflows. Troy, it sure looks like equities reign supreme in terms of inflows. Any thoughts here on this first seven months in the rotation that we saw in July? Yeah, equities have dominated the inflows year to date. So far, about $320 billion have come into equity-based products. You compare that to fixed income, which is about $155 billion in inflows, both very big numbers, but two to one compared to equity versus fixed income. If you look at 2003, it was much more in line with each other. And I think it goes to show that investors are chasing that rally.

We're setting all-time record highs, and they want to have that equity exposure in their portfolios. What is the relationship of flows to prices, for example? I mean, it seems logical to me, having done this for 30 years, that flows, will follow prices, but is that, I'm trying to figure out how much of a tell flows are. You can have prices go up and not have flows, but you can have prices go up and have flows, and then you can have very little movement in prices and flows go up. What's the, have you, you've been studying this for years. What does flows help us understand?

So it helps understand buying behavior and investor sentiment, but the ETFs because you can short them, you can also get some wrong takeaways. For instance, back during 2020, we saw massive inflows into energy, but that was because investors were buying our energy ETF and then shorting it on the secondary market, sort of a long-to-land type of create activity. So you have to really look beneath the surface, but when I look back at July, we definitely see trends emerging

with our risk on because you can start to paint this theory by looking at multiple areas that are receiving the same type of price momentum. So if we were to run a momentum score on sectors, It basically looks at technology, then financials, then utilities is one, two, three. And what were the top three sectors getting inflows in July? It was technology, it was financials, and then utilities, which kind of seems a little bit odds with the other two sectors, high growth and the cyclical. Okay, so it makes sense, though, absent weird shorting, normally flows will follow prices. There is a relationship. Here there was, clearly, right?

There's going to be a relationship on sentiment. Sometimes you're going to have secular drivers that are going to prop up the ETF market because there's so many different use cases. We see that within international developed ex-US ETFs. They took in $4 billion in July. But when you look at it more broadly, and you look at what EM had done in single country ETFs, so China had outflows, Mexico had outflows, European-based ETFs had outflows. It was very U.S.-centric, which I think speaks to the market rally. But also what might have transpired on the political scene in July where we started to see the polls,

shift one way. Okay. So we also saw significant inflows into fixed income ETFs. The first seven months, as you heard Troy say, record 156 billion dollars in inflows. Investors love these 4% yields guys. I mean, that is very very sticky money, but the 10-year yield just dropped below 4% today. So we saw these ISM numbers that were a little weaker than expected. Look at these inflows here. Fixed income is still pretty strong here. So we dropped below 4% on the 10 year today. I don't know.

I know you're not a prognosticator on the economic front, but might that fact reverse some of these inflows that we've seen? So I don't think so. I think we've seen investors use fixed income ETS for different reasons, one of them to extend on duration, and sort of harness some of that duration-induced price appreciation from yields coming down and prices rising. I think that is likely to continue on to the rest of the year

if we start to see yields coming down further on that tactical use case. But also, if yields are getting lower, you need investors to sort of get that coupon and where's that going to come from in the fixed income space. It's going to be credit. We've already seen that trade materialized so far this year. And in July, in July, credit-related sectors, investment grade, high-yield, bank loans took it around $13 billion, 50 billion on the year, which is roughly about 40% of all fixed income flows this year. So definitely biased toward credit because of that yield, because of the economy, because of growth. I think there's some tailwinds there for that to continue into the... the rest of the five months of 2024.

We also see today, I just did a story earlier, utilities are up today, real estate investment trusts are up. So you're all favorite con-eds of the world, Edison, are up today. I mean, the idea here is that yields in treasuries come down, it makes it more attractive for, to buy utilities at this point.

Yeah, I mean, so utilities, like I said earlier, really strong inflows in July. We also have dividend DTFs. Dividend ETFs have strong inflows in July as well and makes that sort of relative trade. You can't get that, income out of bonds, where you're going to find that yield? You can't get the income out of treasuries, you're going to have to go somewhere else. And within the ETF industry,

there's a lot of options now. How about that, Troy, dividend? That's not a phrase we heard much all this year. What do you have, SDY is your, is the spider dividend, right? Yeah, SDY. Any sense that might be more attractive for people in the second half of the year? Yeah, I think investors are always looking for that yield play. There's a number of different products that offer it and they've come to market recently with synthetic income or dividend plays but ultimately clients are going to want to chase that yield and and have products that can provide yield to their portfolio and offset some of their other equity exposure so a lot of our clients are coming in and using those

dividend plays as sleeves of their portfolios outside of their core portfolio of ETFs yeah it's remarkable even though the S&P 500 is what one and a half percent dividend yield somewhere right around there. There's an awful lot of stuff that's in the 3% range and it's not just some reits. There's energy stocks. There's some financials that are out there right now. It's curious because in theory, you know, the academic literature is dividends don't really matter. It just reduces the balance sheet.

You're just distributing money but you're not getting free money. It's funny. Some people think the dividends are free money and you explain to them well if you're reducing the balance sheet. You know, it's not, that would be a great trick if we could do that. And ex-dividend, the stock should drop. If you're distributing 2%, you know, theoretically the stop should drop 2%. Otherwise, you really are getting free money.

But people seem to love dividends. They believe in them strongly. There's a very dedicated class. I have noticed that 30 years at CMBC that really likes getting their dividends. If you explain them it's not free money, they kind of get it intellectually, but they'd still like the distribution. idea. And now there's a new way to play if you're looking for those distributions and those are the synthetic income ETFs. So if you want to maintain that core equity exposure, there's plenty of

sponsors that are now using option overlays in order to get that yield with outside of your core equity holdings. I want to just ask you about the upcoming presidential election. Is there any way that might be influencing chart or fund flows? For example, Former President Trump, I know obviously favors less regulation. And that could that benefit, I don't know, financial services firms or health care or something like that where there might be, he might want less regulation, for example. Is there any play here even around the presumptive Democratic nominee Kamala Harris? Yeah.

So, I mean, well, I was just a former President Trump's poll numbers move higher in July. And at the same time, we saw different sort of Trump trade 2.0 effects take place where, like I said earlier, you know, China, ETFs had outflows. And, of course, former President Trump's very harsh on tariff policies and trade policies. We saw Mexico, ETS have outflows, basically 11% of their overall assets, emerging markets, same thing. And on the regulation front, financials, they would uniquely benefit their more service-based, but also maybe potentially less regulatory constraints that could help bolster balance in capital. balance sheets on their capital. So we saw some flows, obviously, in the financials as well. Domestically oriented industries like Small Cap did well as well.

So I think still too early to tell, but as those poll numbers are erratic, you're going to start to see shifts in and out as the market tries to suss out where you want to be based on some fiscal policies that are coming to the market in November. Again, this is sort of a political play here, but, I mean, to the extent that former President Trump's relies a lot on tariffs and protectionism, that would be a negative for international. national investing. We're negative for China investing, it would seem to me, wouldn't it? Yeah, absolutely.

And we've seen that in the flow so far. I think another thing that people are looking at as his poll numbers were going up was the reflation trade or the reshoring trade. So basically bringing supply chain and processes back to the US, and that would ultimately favor small caps. We saw that about a month ago when there was big inflows and positive performance into the small caps and that's because they rely on a lot of revenue from the US so bringing more jobs back more processes and supply chains back within the US

will help drive that and yet that's a very expensive process isn't it I mean globalization works because it's centralized supply chains which reduce costs and get created very efficient distribution lines if you're going to dismantle that start building fab plants a semiconductor plants in Arizona for tens of billions of dollars. Maybe it's better for national security reasons, but it's going to cost more, right? It's inflationary to do that. Well, I mean, I think that's another thing about this election is that some of the policies on both sides of the aisle are likely to be inflationary. And I think they're also likely to extend the fiscal deficit, too. And also,

I think probably most people can agree upon is that this election is likely to stem some volatility. So if you take those three factors combined of like maybe potentially reflationary, extending your fiscal deficit, which never really a good idea, then also macro volatility because of uncertainty. I think irregardless of policies, one of the plays that investors wanted to be considering is gold just to manage those macro risk shocks, but also the impact of some of these policies

on your fiscal deficit and inflation. Yeah, it's not easy to figure out. We're now in month August. Traditionally, August is a lousy month for the stock market, and it's also a month where we traditionally see outflows in ETAFs. of the few months I think you're the expert isn't usually get outflows it's it's usually the weakest we've seen out why is that more people are at the beach I don't know I mean that could be one reason flowing out to the ocean where I mean

what happens they sit there and they say I'm not putting any money I mean yeah that's obviously anecdotal but you know part of it is there's a little more macro risks in August I think a lot of people don't realize that fundamental news stops you don't really have as many earnings reports and lately Jackson Hole's been a very big market moving event and now this year it's We're going to be sort of stuck in this macro vortex. You're going to have a lot of economic data coming out, trying to figure out what the Fed will do next.

You're going to have a handful of political headlines, including the DNC. And it's going to be a lot of these macro risks. So August is presenting a little bit of challenge to this $1 trillion mark. But so far this year, the pace that ETS have been on have been sort of, you know, unstoppable sort of force.

How about you? We were talking about maybe a trillion dollars in inflows this year. We're heading. and we're 60% of the way there looks like. Can we do that? I think we have a good shot at it, but I think investors are going to want to see some clarity from the election.

So I think those last two months are going to prove to be the turning point and telling point whether we can get to $1 trillion. There's a ton of money on the sideline, like Matt pointed out earlier. I think if we continue to grind higher, people are going to race to put that money to work before the end of the year. if there's no pullback. Yeah. It's a very tricky market to call right now.

This is why Jack Bogle, founder of Vanguard, a man who influenced me a lot, said it's time in the market, it's not timing the markets that matters here. You might want to just understand what your risk factor is and stay invested and stay with your plan at this point. Very tricky to go in and out of the market

in these kinds of situations. Gentlemen, thank you very much for joining us. 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 the podcast. Troy Donnyu, head of America's portfolio trading at BTIG, continues with us now. I wanted to get to some other points, Troy, about where we're going with ETFs. Obviously, record years so far.

We'll see if we hit a record by the end of 2024. But there seems to be a lot of new opportunities out there. We have how many products now? 3,600 ETFs? Over 3,600 different ETFs. Yeah. We've seen in the last few years the birth of these buffered strategy products. We've seen cryptocurrency, single stock ETFs.

There's all sorts of new products coming in here. And yet the bulk of the money still goes into plain vanilla index funds, S&P 500, Russell 2000 kinds of funds. Yeah, absolutely. Most of the inflows this year were on the equity side into those funds you just mentioned. But with 3,600 different ETFs, there's all different types of strategies. and plays for both retail and institutional investors. They can utilize these types of products, whether it's buffer where you cap your upside

in exchange for a buffer on the downside or cryptocurrency ETFs, which got approved earlier this year with Bitcoin in January, or even the synthetic income ETFs, which have equity exposure and overlayed with options. It's quite amazing to watch the success. of the synthetic income. So here you are selling a, you're owning the S&P 500, you're selling a call, you're collecting income. So there is a cap, obviously, if the market keeps going up on you. But you are, there is some protection because you're collecting income. This was the perfect product at the perfect time. It really was. In 2022, when we were down, all of these baby boomers who were in

the market, like me, who are smart enough to say, I don't want to sell. I still need to be in the market and be exposed to the market, but I'd like some protection. That was sort of the perfect product. This was a product. I've often had problems with ETF products. They don't make sense to me. But this was a product that made a lot of sense for the time. And it's done very well.

JEP Morgan. That's an enormous product that just took off JEPI. Yeah, absolutely. And there's a number of different products. It's not a new strategy, but it's starting to catch fire with the investors. and many sponsors are starting to put that into an ETF wrapper. So there's a handful of them. You can get SPY, you can get the Q's, and take in income on the side.

Investors are always looking for that yield, and those are great plays to get it through an ETF wrapper. Another thing is to see, there are still companies that are not in the ETF space, and they're getting in. So we saw Capital Group, we saw Alliance Bernstein, Newberger-Burman. They've all entered the ETF space in the last few years. And we have people converting existing products, existing mutual funds into ETFs as well. So there are still entrants coming into the space. Yeah, absolutely. It's still maturing product.

There are those entrants that you mentioned along with other smaller entrance that are sponsors launching more niche products. But all of these entrants bring new products to the market that allow invent. to get a different segment of the market. And it helps with the inflows as well. Any mutual fund conversions that come over, SMA conversions that come over to the ETF wrapper are inflows into the ETFs. Yeah.

And yet it's not all rosy. Just because there's 3,600 funds, doesn't mean there's 3,600 successful funds. A lot of them launch, and a stockingly large number of ETFs have less than $100 million. I think more than half have less than $100 million in assets in them. in them. One thing I remember very well is the thematic funds we were just

talking about this about they were such a big thing, thematic tech in 2017, 2018, 2019, cyber security or anything of that kind, some kind of subcategory of tech launched, a lot of them launched at the very height, drew a lot of money in, and then underperformed for years later. So not everything is terribly successful. A lot of ETSs tend to be trend chasing. Yeah, absolutely. And typically, you'll see the flows come into hot products at the time. Cybersecurity ETFs launched right around that Sony hack, which had notoriety. Now, if you look, a lot of people are chasing the artificial intelligence returns.

But overall, this year, we've actually seen net $2.5 billion out of the thematic space. So that goes to show that investors are still weary about the rising rate interest environment, where they were burned in 2022, 2023, as rates rose. And some of these smaller companies that weren't profitable didn't do well within those thematic ETFs. It's also a warning. These are really slice and dice niche products. And they tend to have moments where everybody gets in.

This happened with pot ETFs. It sure seems to be with crypto and Bitcoin. It's happened with thematic tech. And you guy in at the time, and then the interest wanes, even though the ETFs continued to stay on. You know, Jack Bogle, the guy who had huge influence with me at Vanguard, used to say that if you honestly know how to evaluate where you are at in your portfolio, you'll probably find this going to be difficult to outperform using these kinds of very, very small niche products.

So it's an interesting, I'm in favor of the idea of new ETFs launching, but as an investment idea for long term, it's a tough play. tough play. Bogle really was right. owning the broad market is for most people still the best way to go. Troy, thanks very much for joining us. Really appreciate it. That does it for this week's ETF Edge, the podcast. Thanks for listening.

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