Sector Investors Adopt a Defensive Posture

Earlier in the year, we saw equity weakness globally associated with tightening monetary policy and rising rates. This upward rate move pushed investors out of bond-proxy stocks typically found in Utilities and Real Estate – two rate-sensitive industries. But during October, investors moved in favor of these groups, as these classic defensive industries offer relative stability during times of uncertainty. Healthcare was another winner, as investors who still favor growth but are wary of technology valuations, are rotating to this more defensive industry. Lastly, investors fled more tariff-sensitive sectors such as Industrials and Materials, in which a few key earnings announcements showed that supply chains are destined to be disrupted by impending tariffs.

Positioning Toward Yield and Value Equities

2018 equity style performance trends have been all about growth. Yet, lately, we’ve written about increasing flows into the value factor, which has shown strength when highly priced technology shares have sold off. Investors have viewed these sell offs as an opportunity to take profits and rotate into shares that are underpriced relative to their fundamentals, hoping these value stocks can turn around their performance and help portfolios preserve the gains that have accumulated during the past decade. Thus, October saw a continuation of value’s flow momentum, as the category picked up $2.6 billion in net new flows. Another factor that has struggled is yield, which has been down significantly given the increase in borrowing costs. But recent defensive posturing has renewed interest in these high-dividend funds; investors have now placed $1.6 billion net new into the category over the past two months, the most since October and November 2017.

Record Monthly Outflow for High Yield

As rates have risen furiously this year, it has been a difficult year for all sorts of fixed income, especially anything with duration. But with the U.S. economy humming along, high-yield fixed income has been a relatively strong performer in a weak crowd, and junk bond credit spreads have largely narrowed to record tights relative to investment-grade. Yet, amid some weak performance from the energy sector, October saw this swiftly reverse, and in fact credit spreads moved to their widest levels all year. Against this backdrop, investors redeemed $4.1 billion in high-yield ETFs, a record monthly outflow for the high-yield category. This October’s “redeem high-yield” trend is not abnormal – the category has seen net outflows in six of ten 2018 months, and even a fair amount of “create-to-lend” activity, with several big high-yield funds at record high short-interest levels. Also of note, investors plowed into ultra-short duration funds to the tune of $5.8 billion, adding to record year-to-date inflows for the category at $29.5 billion. The next closest yearly total came in 2017, with only $11.1 billion in net new flows. Participants have been feverishly lowering duration exposure amid rising rates.

Eye on the Turkey

Trick-or-treat has come and gone, and the United States has seen plenty of spooky episodes, both holiday and market related. Only time will tell if this October turns out to be just a quick thriller or the start of a horror flick, but in the meantime, we’re looking to turkey and football to provide a better backdrop for markets. Specifically, capital gains season should drive retail investors to utilize the ETF vehicle even if asset class performance disappoints. As institutional investors and trend followers continue to follow performance with flows, let’s see if investors with a longer-term view can keep net flows afloat even if markets continue to spook participants.