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10 ETFs to Navigate Quickly Changing Market Conditions

This article was originally published on ETFTrends.com.

ETF investments provide advisors and investors with an idea of currently trending global investment themes popping up in a changing market environment.

On the recent webcast, ETF Flash Flows: Where Are the Markets Today?, Matthew Bartolini, Head of SPDR Americas Research for State Street Global Advisors, outlined the current market environment, highlighting outperforming asset categories such as the U.S. small-caps on the equity side, high-yield on the fixed-income side and broad commodities.

Among the various sector picks, financials now exhibit attractive valuations relative to its own history and the broader market. Defensive and rate sensitive sectors, such as health care, real estate and utilities, also show strong momentum on the recent rebound. Bartolini, though, warned that the recent rally stretched U.S. valuations, but emerging market stocks, on the other hand, remain below or near their historical median range across multiple valuation ratios. Bargain hunters have already increased allocations to emerging markets while U.S. sector flows are starting to rebound from 10-year lows.

Additionally, Bartolini underscored the recent outperformance of the quality smart beta factor. Quality took the lead last month and was the best performing factor over the past three months while the small-cap rally continued. The minimum volatility factor, though, remained the best performer over the trailing 12 months after a year of heightened market swings.

Investors have exhibited an increasing preference for smart beta or factor-based indexing methodologies. Fund launches have grown more sophisticated with various multi-factor blends and quantitatively-driven products hitting the market. For example, so far this year, investors funneled $5.3 billion into low volatility, followed by $2.8 to quality and $2.2 billion to multi-factor strategies. Over the past year, about $15.3 billion went into low-volatility, $14.1 billion into dividend and $10.5 billion into multi-factor strategies.

Fund flows also revealed an increasing preference for ETFs among the investment community as the U.S.-listed ETF industry continues to grow at the expense of active equity mutual funds. Bartolini pointed out that mutual funds not only had to endure market declines last year but outflows as well, with the majority of investors yanking money out of active strategies.

More investors have become fed up with the underperformance of active managers and high fees. For example, only 16% of actively managed U.S. large cap blend funds outperformed versus their prospectus benchmarks. About 37% of total active equity managers outperformed their prospectus benchmarks. Meanwhile, $1.3 trillion of actively managed assets underperformed and also cost investors $14 billion in fees while underperforming.

Investors also took a hit for the tax season with capital gains after the negative market and high possibility of below benchmark returns. Over 60% of mutual funds paid capital gains in 2018, compared to just 6.2% for the U.S.-listed ETF industry.

Fund flows also revealed a shifting risk tolerance as more investors dived back into the equity markets. Equity funds reversed course taking in over $15 billion in inflows last month while fixed-income flows still outpaced equity year-to-date. Bartolini argued that the net outflows from government bond ETFs also indicated renewed risk-taking sentiment. For example, investors favored higher yielding segments last month and rotated out of short-term government debt.

Looking ahead, investors seem to be taking on a more defensive outlook as the extended bull rally heads toward the late innings.

"Slower global economic growth, higher volatility, less accommodative monetary policies and decelerating earnings growth likely mean lower returns for investors in 2019. As a result, more countries are likely to pursue aggressive fiscal policies to reignite growth and soften the blow from tightening monetary conditions," Bartolini said. "Therefore, discerning investors may be able to uncover a greater number of high quality investment opportunities in 2019."

For example, investors can look to strategies that focus on quality or companies that exhibit strong fundamentals over growth such as the SPDR S&P Dividend ETF (SDY) and SPDR MSCI USA StrategicFactorsSM ETF (QUS) .

"Rotate from high growth into quality growth at a reasonable price to take a more defensive position," Bartolini said.

Investors can also consider defensive fixed-income plays by moving down the yield curve and targeting strategies with a focus on short-duration in an attempt to mitigate potential interest rate risks, including bond ETFs like the SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN) ,  SPDR Portfolio Short Term Corporate Bond ETF (SPSB) , SPDR Barclays 1-3 Month T-Bill (BIL) , SPDR DoubleLine Short Duration Total Return Tactical ETF (Cboe:  STOT) and SPDR Blackstone/GSO Senior Loan ETF (SRLN) .

"Shorten duration and move up in quality to mitigate duration induced price declines and the seemingly abundance of macro risks impacting the markets path ahead," Bartolini said.

Lastly, the SPDR S&P International Small-Cap Fund (GWX) , SPDR S&P Emerging Markets Small Cap (EWX) and SPDR S&P China ETF (GXC) could allow investors to capitalize on the emerging markets as they benefit on fiscal policy changes.

"Target non-US regions that may benefit as fiscal policy goes global due to populist regime shifts seeking to fuel domestic growth," Bartolini added.

Financial advisors who are interested in learning more about major global investment themes can watch the webcast here on demand.

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