Monthly Brief January 2019 – Messages from the ETF Markets
The best headline recapping January… “What a year this month was”. The bounce in late December continued into 2019, and then some. Just about every asset class was higher during the month, including many global indexes. But now the pressure is on for the markets’ next act. Could there be further follow-through? Or has the bounce run its course?
First, the good news – Q4 2018 earnings have generally been healthy and in-line with expectations (albeit on reduced growth rates), the US government reopened for business and the Fed capped off the month by easing off their path of tightening financial conditions and saying “uncle” to those who felt their actions were prematurely restrictive.
Across from the good news are items still outstanding, such as Brexit, a slowing Chinese economy and global trade relations. If it sounds familiar, it is, as these items have plagued investors’ confidence for quite some time. And January’s rally may very well have been, in part, a reflection of investor fatigue regarding the deluge of headlines about these issues. Once concerning, now common, investors may be more inclined to think of these headlines in the vein of “the boy who cried wolf”.
Of course, looking at a market move in the context of the calendar can be misleading. While the markets’ 2019 advance has certainly eased investors’ minds, it must be viewed in the broader context, which shows the S&P 500 Index still 7% below its September 2018 all-time high. And if the underlying economic backdrop does remain solid, why did the Fed feel compelled to change course from normalizing its policy to remaining more “market-friendly”? From this perspective, confidence in further gains may be somewhat tenuous.
The December 2018 lows may prove to have been a washout bottom for global equity markets, setting the stage for another leg higher in the post-financial crisis era. But one can imagine that this would require more evidence of solutions to the many global macro concerns that have plagued investor confidence during this volatile stretch. The coming weeks will see 2018 earnings reports run their course, further US-China trade negotiations and a Brexit deadline. And each will be reported on minute-by-minute. Will investors have a clearer picture of the path of the global economy, or more noise to contemplate?
CHART OF INTEREST – MESSAGES FROM THE ETF MARKETS
While standard market averages provide headline information on the global markets, a better understanding of the markets’ message is often found by assessing the underlying data. Looking into the investor actions which have driven moves within the capital markets can be very insightful. In this regard the exponential growth in the Exchange-Traded Funds (ETFs) market has provided a tool by which one can see actions of both institutions and individuals.
Looking at this data, there appear to be some unexpected disconnects between the market results in January and investor activity. The first, and unexpected, observation would be the net outflows of nearly $18 billion from ETFs representing the equity asset class. This, during a month when equity markets had strong, positive returns. While this can be the result of many different factors, intuitively, one would typically expect a month of strong returns for an asset class to coincide with strong net asset flows, suggesting investor conviction regarding the prevailing market trend. January’s dynamic suggests tepid investor confidence of potential follow through of the equity markets’ bounce and will bear close watching as we continue further into 2019.
A second observation would be the continued dominance of the traditional equity and fixed income asset classes. In particular, the “Alternative” asset class continues to represent only a small fraction of investors’ ETF holdings, despite continuing to receive a great amount of attention in the media and investment community. The merits of this category are strong, but often misunderstood. And the relatively small level of ETF assets the category has claimed supports this disconnect. This is likely due, in part, to a hesitancy (complacency?) to incorporate the asset class into portfolios during the lengthy post-financial crisis era of generally rising equity markets, central bank buffers for fixed income markets and, in hindsight, where each bout of volatility has been seemingly only temporary. Should we be entering an era in which equity market gains are less consistent and the fixed income asset class is challenged by rising interest rates, the alternative asset class may well be primed to grow.
While this is only one month’s data, the trends in these datapoints bear watching for evidence as to the health of global markets and where potential opportunities and risks may exist.
James Ferrin, CFA
Chief Investment Officer
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