Displaying items by tag: macro

Buffered ETFs are seeing explosive growth. The category had less than $200 million in assets and now has $36.7 billion. The major appeal is that they allow investors to remain fully invested while offering downside protection. 

However, they do tend to have higher costs and may not be appropriate for many investors. Buffered ETFs follow a benchmark while also using stock options to limit downside risk and capping gains on the upside. 

These products are modeled after structured notes, which have proven to be popular among high net worth and institutional investors. Like structured notes, buffered ETFs follow some sort of lifecycle, which means that advisors and investors have to consider market conditions when making a decision. This means they are not appropriate for rebalancing or dollar cost averaging strategies. An important consideration is the start date of the buffer ETF and the performance of the underlying index since the start date, as this could affect the value and desirability of the buffer.

According to Jeff Schwartz, president at the investment analytics firm Markov Processes International, “There is a lot to understand with buffer ETFs, and the history of structured products shows that both advisors and investors often do not fully understand the nuance of these vehicles." 

Finsum: Buffered ETFs are experiencing a surge in growth. The upside is that they allow investors to remain fully invested while capping the downside. However, there are also some downsides to consider.   

Entering the year, there was optimism around real estate stocks given consensus expectations of rate cuts due to inflation falling to the Fed’s desired level and a weakening economy. However, the economy has defied skeptics and remains resilient, while inflation is plateauing at higher levels. As a result, the Fed will be less dovish than expected, and the market has tapered back expectations for rate cuts to between 1 and 2 by year-end. 

Another consequence of the data is that mortgage rates are trending back to last year’s highs, with the 30Y at 6.9%. The real estate sector sank lower following last week’s inflation report, led by self-storage companies, office REITs, and homebuilders on the downside. 

Over the past month and YTD, the Real Estate Select SPDR Fund (XLRE) is down 4.6% and 7.8%, respectively. The current environment of rates at a 23-year high is clearly a major headwind. And there are no indications that the status quo will meaningfully change until there is improvement in terms of inflation or more damage to the economy. The impact is evident in terms of Fed futures. At the start of March, odds indicated more than a 50% chance that there would be four or more rate cuts by the end of the year. Now, these odds have plummeted to 5%. 

Finsum: Real estate stocks have sunk lower in the last month, along with the odds of aggressive rate cuts by the Fed. As long as ‘higher for longer’ persists, there will be considerable stress for the weakest segments of the real estate market.

The Energy Select SPDR ETF (XLE) is up 14% YTD, which is the second-best performance among sectors. This follows a year of underperformance in 2023 due to concerns of a recession impacting energy demand, while strong US production offsets the impacts of OPEC cuts. Last month, OPEC announced that production cuts of 2.2 million barrels per day would continue in the second quarter.

This year, oil prices have risen due to increased tensions in the Middle East. Additionally, recent economic data has clarified that the US economy is not near a recession, and there are some indications of a pick-up in economic growth. The near-term macro picture looks bullish for energy stocks given increased demand, tighter supply, and intensifying geopolitical tensions. On the supply side, OPEC has demonstrated discipline in terms of members abiding by agreed-upon production cuts, and US production is expected to not increase further.

Given valuation concerns about many parts of the market, energy stocks are also cheap, trading at 13 times expected earnings vs. 21 for the S&P 500. XLE also pays a 3% yield, which is more than double the S&P 500’s yield of 1.4%. Further, historical research shows that energy stocks have posted the best performance in high-rate environments, which is likely to persist for longer given recent economic data. 

Finsum: Energy stocks have had a strong start to 2024. Recent economic data is supportive of increased demand, while the supply side is being impacted by OPEC cuts and heightened geopolitical tensions. 

Active fixed income demand is surging. The secular drivers are increased comfort and adoption by advisors and investors with the category, in addition to the conversion of actively managed fixed income mutual funds into ETFs. From a cyclical perspective, the current environment, which has attractive yields but considerable uncertainty about the Fed and economy, also favors active fixed income strategies.

Despite its growth, active fixed income makes up less than 4% of allocations, revealing that there is more upside. As long as the Fed remains in a wait-and-see mode, active fixed income is likely to remain in favor. And this period of uncertainty has certainly been extended following the recent string of robust inflation and labor data. 

This type of rate environment requires a more flexible and agile approach, which is better suited for active fixed income. According to Bryon Lake, JPMorgan Asset Management Global Head of ETF Solutions, “To me, it’s all about active fixed income. With what is happening in the rate space, investors are all rethinking their fixed income allocations as we speak. We want to talk about active fixed income … where investors can dial in the exposures that they’re looking to get in the ETF wrapper.”

Finsum: Current uncertainty about the timing and number of Fed rate cuts in 2024 has been a major contributor to the growth of active fixed income. And this uncertainty has increased following recent economic data. 

Treasury yields jumped higher following the hotter than expected March CPI report. The 10-year Treasury yield moved above 4.5%. It has now retraced more than 50% of its decline from its previous high in late October above 5%, which took it to a low of 3.8% in late December, when dovish hopes of aggressive rate cuts by the Fed peaked.

Clearly, recent labor market and inflation data have not been consistent with this narrative. In March, prices rose by 3.5% annually and 0.4% monthly, above expectations of a 3.4% annual increase and 0.3% monthly gain. Core CPI also came in above expectations. 

Instead of trending lower, inflation is accelerating. Now, some believe that the Fed may not be able to cut rates given the stickiness of inflation. Additionally, economic data remains robust, which also means the Fed can be patient before it actually starts lowering the policy rate. 

Some of the major contributors to the inflation report were shelter and energy costs. Both were up 0.4% and 2.2% on a monthly basis and 5.7% and 2.7% on an annual basis. Shelter, in particular, is interesting because its expected deceleration was central to the thesis that falling inflation falling would compel the Fed to cut.

Finsum: The March CPI came in stronger than expected, leading to an increase in Treasury yields. As a result, we are seeing increasing chatter that the Fed may not cut at all.