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ETF Wrap: ETF investors grapple with ‘manic depressive’ stock market after September flows signaled ‘risk-off bias’


Hello! ETF flows were “resilient” in September, but have you looked beneath the surface? Citi saw “a clear risk-off bias.” Markets have been volatile as there’s “deep lack of conviction” as investors cope with Fed-related anxiety, the chairman of Davis Advisors tells MarketWatch in this week’s ETF Wrap.

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Money has kept flowing into exchange-traded funds despite a rocky September, but there were signs of wariness as investors continue to grapple with big swings in markets and anxiety over the Federal Reserve’s aggressive monetary tightening.

There’s been “a manic depressive quality” to the stock market, said Chris Davis, chairman of Davis Advisors, in a phone interview. “You have this dramatic oversteering” both up and down. 

That’s because many investors harbor a “deep lack of conviction” about the direction of equities, focusing on weekly data that has stoked hopes and fears about the market and the economy, according to Davis. He also pointed to “enormously bearish” sentiment among investors as the Fed aggressively hikes interest rates, after holding them unnaturally near zero.

“What we are starting to see is actually a return to normalcy – an unwinding of a massive distortion,” said Davis. “What has terrified the market is a huge reversal.” 

While ETF flows remained “resilient” in September, a look beneath the surface reveals that “a clear risk-off bias persisted last month across not just equities, but fixed income as well,” according to a research note from Citigroup on Oct. 4. 

“ETF investors were not high conviction buyers as flows continued to focus on low volatility exposures within each asset class,” Citi analysts said in the note. “September flows followed the enduring year-to-date trend of cautious allocations.”

US-listed ETFs attracted $23.5 billion in net new assets last month, with U.S. equity funds leading inflows, according to the note. U.S. equity ETFs saw $15.5 billion of net inflows, followed by fixed income with $11.4 billion, the report shows. 

But “strong U.S. equity trading ETF inflows may be misread,” warned the Citi analysts. “A spike in shares outstanding could be a sign of continued short demand.”

Investors who short securities are wagering that they will decline. 

Citi considered that “capital markets and options dynamics” are influencing flows of heavily traded U.S. equity ETFs. Short interest has risen in such funds, the analysts said. While these funds had large inflows in September, “we doubt it was potential dip buying,” they wrote. “Instead, we suspect it was further hedging.”

‘Sentiment overshoots’

Citi this month lowered its year-end target for the S&P 500

by 200 points to 4,000, which is above current trading levels. 

After large back-to-back gains this week, the S&P 500 slipped 0.2% Wednesday to close at 3,783.28. The index had tumbled 9.3% in September for it biggest monthly percentage drop since March 2020, when U.S. stocks tanked on COVID-19 fears.

The SPDR S&P 500 ETF Trust

was down 1.1 % Thursday afternoon, bringing its decline so far this year to more than 21%, FactSet data show, at last check. 

“Sentiment overshoots that have priced in recession risk serve as a basis for our near-term risk-on rally call,” the Citi analysts said. 

Read: The stock market is wrong: the economy isn’t going to ‘blow a gasket’ just yet, warns economist

Meanwhile, ETF investors’ persistent preference for low risk aligns well with the weak sentiment readings Citi is seeing in its broader U.S. equity strategy research, according to its note on Oct. 4.

Bearishness has been building despite US-listed ETFs in September seeing “another solid month of new asset gathering,” with details beneath the surface of last month’s flows indicating that investors were “clearly reluctant buyers of ‘risk,’” according to the Citi analysts.

“Flows skewed to lower volatility exposures across asset classes,” they wrote. “This mirrors the trend that has been in place all year.” 

ETF investors historically have been “more eager to put money to work than other investor bases,” according to Citi.

In equities, the flow bias this year has been towards strategies with low volatility and involving dividends, the analysts said. “Investors have shied away from more volatile exposures,” such as smaller-caps, “generally unprofitable themes” and some single-country, emerging market strategies, their research found. 

Meanwhile, stock market volatility has risen recently, with the CBOE Volatility Index trading around 30 Thursday afternoon, according to FactSet data. 

Citi saw panic

“ETF investor reluctance coincides with falling gross and net futures positioning data as well as a ‘panic’ level from the Levkovich Index,” Citi’s proprietary sentiment gauge, the bank’s analysts said. “It hit ‘panic’ in September for the first time since the onset of the pandemic.”

Clients of Davis Advisors have indicated a preference for U.S. equities over international stocks, according to its chairman, Davis. “If people are panicked, they do not want to be looking internationally,” though international stocks look relatively cheap, he said.

The firm’s Davis Select U.S. Equity ETF

is down around 22.8% in this year’s bear market, while the Davis Select International ETF

has dropped 19.7%, according to FactSet data based on Thursday afternoon trading. 

But the firm’s Davis Select Financial ETF
which Davis said is substantially invested in U.S. stocks, has outperformed both of those funds so far in 2022. It’s down around 16.8% this year based on Thursday afternoon trading.

“We tend to be very conservative in how we build that portfolio,” he said, noting that he likes the financial stocks partly for their dividend yields. 

Hiding in bonds?

Within fixed income, ETF investors have “shied away from both credit and interest rate risk per the flows data,” according to Citi. “Ultra short and short Treasury ETFs were the most popular flow winners in September and year-to-date,” the analysts said. 

Investors favored short-duration bonds after last month getting a reading on inflation that was higher than anticipated, according to Matt Camuso, ETF strategist at BNY Mellon Investment Management.

“Ultra short ETFs were a huge gainer in terms of ETF flows in September,” he said. They were “buying things like one-to-three month T-bills,” he said, “taking duration risk off the table” amid fears that the Fed would have to keep up its aggressive path of rate hikes to tame stubbornly high inflation.

Read: These long-duration bond ETFs have cratered the most from their peaks over past year, sinking below other assets as U.S. dollar soars

Camuso said that investors were also “selling out of high-yield” as they “tightened up” their portfolios from a risk standpoint amid concern that hawkish Fed policy might push the U.S. into a recession.

“Combined, the flow, positioning and sentiment data help support our near-term view that we could see a risk-on reversion into year-end as bearishness gets too extended,” the Citi analysts said. “Still, our medium-term view is more muted on growing Fed policy error and severe recession risks.”

As usual, here’s your look at the top and bottom performing ETFs in the week through Wednesday, according to FactSet data.

The good…

Top performers


VanEck Oil Services ETF


SPDR S&P Oil & Gas Exploration & Production ETF


iShares MSCI Brazil ETF


First Trust Natural Gas ETF


iShares U.S. Oil & Gas Exploration & Production ETF


Source: FactSet data through Wednesday, Oct. 5, excluding ETNs and leveraged products. Includes NYSE, Nasdaq and Cboe traded ETFs of $500 million or greater.

…and the bad

Bottom performers


Vanguard Extended Duration Treasury ETF


PIMCO 25+ Year Zero Coupon US Treasury Index ETF


iMGP DBi Managed Futures Strategy ETF


Vanguard Short-Term Inflation-Protected Securities ETF


iShares 20+ Year Treasury Bond ETF


Source: FactSet

New ETFs

Distillate Capital announced Thursday that it launched the Distillate Small/Mid Cash Flow ETF
to provide exposure to “150 U.S. small- and mid-cap stocks that meet specific parameters involving current and future free cash flow, valuations, and quality.”

VanEck said Thursday that it’s offering the VanEck Morningstar SMID Moat ETF
which is designed to invest in small and mid-cap stocks in the U.S. that “Morningstar believes possess long-term competitive advantages.”

Simplify Asset Management announced Sept. 30 that it launched the Simplify Bitcoin Strategy PLUS Income ETF

to provide exposure to the cryptocurrency as well as potential income from “selling short-dated put or call spreads on the most liquid global equity indices.”

Weekly ETF reads

Brazil ETF surges after country’s tight presidential election results prompt runoff vote (MarketWatch)

You can bet against Jim Cramer with a new ETF from the fund manager who already shorts Cathie Wood’s stock picks (Fortune)

New ETFs Offer Investors a Chance to Bet on the Metaverse (The Wall Street Journal)

Tech stock shocks test concentration risk for ETF investors (Financial Times)

Sparks Fly as Rosenbluth Dives Into the ESG Controversy on ETF Edge (VettaFi)

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