The ETF Themes That Did & Didn't Work In Q1
Treasuries and tech stocks were the big winners, but the banking sector blowup reset the market.
The 1st quarter is officially in the books and it could probably be best described as…..confusing?
On one hand, the rally that occurred in January is understandable. GDP growth, retail sales and unemployment numbers all came in better than expected and had investors believing that maybe a recession could be avoided. The rally that occurred in the latter part of March was less so. The failures of SVB and Signature Bank caused a minor panic that lasted several days, but the Fed jumping in to backstop liquidity issues essentially mitigated a lot of risk.
Either way, the S&P 500 probably performed better than it should have given the issues in the banking sector and some of the progressively deteriorating economic data. But that tends to matter less when the Fed is throwing hundreds of billions of dollars at the problem and interest rate expectations come way down.
For the quarter as a whole, the S&P 500 gained more than 7%, but the gains were driven by a fairly narrow group of sectors.
The three growth sectors - tech, consumer discretionary and communication services - all outperformed by a wide margin, but that was it. In total, 8 of the 11 sectors underperformed the index. Four of them lost money and another two gained less than 2%.
In general, markets that are driven by just a few sectors and are not advancing broadly are considered less healthy and unsustainable. I’d guess that’s probably going to be the case here as well, especially considering long-term Treasuries gained 7% in Q1 as well. Stocks and bonds don’t tend to deliver those kinds of gains at the same time (in fact, it’s happened only once in the past 20 years - Q2 2021) and the bond market tends to be right more than the stock market.
Outside of sector-specific returns, there were several themes and styles that did well and others that didn’t. Let’s run down some of the quarter’s best and worst.
Winner: High Beta
If growth and tech are leading the way, it’s usually the case that high beta is as well. Nearly 70% of the assets in the Invesco S&P 500 High Beta ETF (SPHB) are allocated to just two sectors - tech and consumer discretionary - so it’s not surprising to see why it performed so well. For the quarter as a whole, SPHB beat the Invesco S&P 500 Low Volatility ETF (SPLV) by more than 14%.
Can the trend continue? This group tends to respond well to loosening monetary conditions and that’s likely what we’re going to start seeing as early as Q2. The latter half of 2023 could be trouble if the latest data keeps trending in the wrong direction.
Loser: Momentum
Momentum investing is one of the most popular methods for rotating in and out of sectors. When done regularly and effectively, it can produce superior risk-adjusted and absolute total returns. When done at the wrong time, it can be a disaster.
Such has been the case with the iShares MSCI USA Momentum ETF (MTUM). It only rebalances itself twice a year. That means if the portfolio changes at just the wrong time, it can be stuck with an out-of-favor portfolio for the next 6 months. That’s what happened with this ETF in late 2022 when it reconstituted itself into the two best performing sectors at the time - energy and healthcare - to the tune of a huge 60% combined weighting.
Guess what are two of the three worst-performing sectors year-to-date? Volatility and sharp, sudden sentiment shifts can really be the enemy of momentum strategies.
Winner: Quality
This one should be fairly intuitive, but it happens less often than you’d think. In markets where fundamentals are deteriorating and the risk of recession appears elevated, it makes sense that investors would flock to equities that are backed by strong balance sheets and cash flows. In a lot of cases, that tends to mean more durable, mature and defensive businesses. When those sectors are out of favor, it can lead to lagging performance.
The quality factor has been fortunate in that it’s been heavily allocated to the tech sector, which has been the star performer of Q1. Given its composition, this won’t always be the case, but it’s a solid strategy to keep in your back pocket in case conditions get worse throughout the rest of 2023.
Loser: Dividends
If you overweighted dividend stocks in 2022, you were probably thrilled with how they performed. In several cases, dividend ETFs, such as the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), generated positive returns even as the S&P 500 lost 18%.
2023, however, has seen a sharp reversal of that trend. Investors moved quickly back into growth stocks when the U.S. economy unexpectedly got stronger and continued to do so when the Fed backstopped any potential liquidity risks in the banking sector. The gap between growth & value as well as dividends/low volatility & high beta has been extraordinarily large this year and one I can’t see getting much larger this year. Conditions have been just right for riskier equities to excel in Q1, but it’s also impossible to ignore the risks that are building here. Dividend stocks may not generate big gains here, but it still looks likely they’ll outperform as the global economy slows.
Winner: T-Bills
The flight to safety trade has finally returned after a year when Treasuries got slammed across the board thanks to the Fed’s rate hiking cycle. The volatility ticking higher and 4-5% yields now available on what’s essentially a riskless asset, investors have taken notice of T-bills again in a big way.
Fixed income has been a net inflow machine in 2023, outdrawing equity net new cash by a 10-to-1 margin on a relative basis. More than 80% of fixed income net flows have gone into Treasuries and nearly 1/3 of the money going into Treasuries has been going into bills.
Those high yields in T-bills just resulted in the iShares Short Treasury Bond ETF (SHV) having its best single month’s performance in March since 2008!
Loser: Equal Weight
When roughly 15-20 mega-cap stocks account for nearly all of the gains in the S&P 500, it’s nearly impossible for diversified strategies to have success. The equal-weighted S&P 500 trails the traditional cap-weighted S&P 500 by more than 5% in 2023. When the market is incredibly top-heavy like it was in 2021 and seems to be again in 2023, equal-weight strategies are almost certain to be underperformers.
ETFs in Focus
Here’s a look at the weekly net flows/RSI matrix, where I try to get a sense of what the markets are doing relative to what investors are doing to see if there are disconnects.
Note: Most ETFs will fall above the 0% flows/AUM line because, well, ETFs take in hundreds of billions of dollar annually. So I’m looking at 1-month flows to focus on the short-term (1-week flows are too choppy to have high confidence in the results). Upper-left quadrant would identify ETFs that are performing poorly but are seeing investor money moving in. The lower-right quadrant would be ETFs that are performing well, but seeing money leaving. Both could provide contrarian opportunities. I wouldn’t call them buys or sells. Just more of a way of potentially identifying trends.
No surprise to see the biggest Treasury ETFs dominating the net flow narrative. Treasury yields have been dropping post-banking sector blowup as the Fed reconsiders its hawkish stance on rates. Volatility has been picking up in both stocks & bonds and that’s likely to keep SHV, in particular, on investors’ radars.
Much of the net flow stories in the biggest ETFs are following recent performance. Real estate, momentum and junk bonds continue to see outflows, but the curiosity of the bench is tech. The Technology Select Sector SPDR ETF (XLK) has seen more than $2 billion leave the fund this year despite a 20% gain
Instagram Post of the Week
Last week, I put up a post detailing the annual reconstitution of the Schwab U.S. Dividend Equity ETF (SCHD), which is perhaps the most popular dividend ETFs out there today. The fund targets companies with high yield, dividend growth and balance sheet quality characteristics, so it does maybe the best job of identifying the truly top-tier dividend payers.
Many of the top 10 stocks remained, but Abbvie (ABBV) was the notable standout, going from not even in the fund pre-reconstitution to the #1 holding after.
Overbought & Oversold
Overbought: SLV, SHV, XLK, BIL
Near Overbought: QQQ, TFLO, EMLC, GDX, IWF, EWJ, MGC, VDC, HYG, MUB, DBA, BITO, SPHQ, ESPO, EIDO
Near Oversold: KRE, KBE, UNG, CNCR
Oversold: MSOS
Note: Oversold/Overbought developed using a combination of RSI and Longbow dashboard.
A brief note…
I’m on Instagram now! You can click HERE to follow. It’s a spot where I’m going to be dropping more infographics, stats and visual content. I think you’ll find it useful for more “quick hits” on the latest trends and ideas!
Hope you’ll join me!