5 ETFs With Big Fund Flows: Could Better Times Be Ahead?

Rudy Martin

Fixed-income investors, refugees from emerging-market investments and gold investors have had a tough go of it lately. And here in the short term, as my colleague Tony Sagami said yesterday, there seems to be even more pain in store.

However, those investors who are reconsidering their positions in U.S. bonds, emerging-market stocks and bonds, and even their gold holdings might provide some relief for investors in U.S. stocks, who are smarting from the panic-selling we saw after Ben Bernanke outlined the Fed’s potential plans for “tapering” QE.

With Fed governor after Fed governor coming out of the woodwork to reassure the public that the QE spigot isn’t in danger of being turned off, trading volumes in stocks and other exchange-traded products are on the rise … welcoming back those investors who had previously left in search of stability and yields.

Now, they are seeing what you already know — that they can have both, simply by choosing the right equity investments!

Whether their return can lift domestic indices out of their current swoon quickly enough is another matter. But in the longer term, when the market gets past its current correction, I think we’ll look back on this period and thank these investors for breathing new life into U.S. stocks and funds.

Let’s take a look at where the money is flowing from … and, more importantly, where it’s flowing to!

Where are the markets headed from here?

It looks like it’s going to be a bumpy summer in the markets. The Dow plummeted over 600 points in 3 days and it’s back to well-below 15,000, even after yesterday’s rally.

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Bond Bears Start to Stir

Earlier this year, returns on bonds dipped so low that experienced investors — including, most notably, PIMCO bond kingpin Bill Gross — realized that little or no room was left for further price gains.

Back in May, Gross hinted that the 30-year bond bull market was ending. Although he didn’t say a bear market in bonds was arriving to take its place, the die was still cast.

With just his one-sentence proclamation posted to social-media site Twitter, hordes of bond-buyers suddenly awakened to the fact that plenty of equities pay competitive dividend yields … and many started transferring their cash from the bond market to the stock market. And I don’t think we’ve seen the bulk of this transfer take place yet.

Developing Markets, Developing Problems

Similarly, emerging-market stocks have started catching the attention of forward-thinking investors in recent months. Most of these stocks, and even the markets themselves, remain just off Wall Street’s radar.

In my Global Trend Trader service, we’ve been taking full advantage of that. During the past two years, I’ve led my subscribers to several double- and even triple-digit gains in these developing economies.

Despite the carnage in the global markets over the past several trading days, I haven’t changed my outlook. I continue to think the best is yet to come as the developed economies continue to lose steam while these younger nations outpace their growth by leaps and bounds.

Right now, however, while these up-and-coming economic powers still have plenty to offer, there’s no question that the slowdown in China’s economic growth — and its reverberations in countries like Australia and Latin American nations that supply it with raw materials — have dampened enthusiasm for the emerging economies.

Plus, China’s growth, while impressive by most countries’ standards, continues to lag expectations. On top of that, the country is actively trying to reduce liquidity, which is weighing heavily on its markets … and on traders’ sentiment as they await the outcome of this engineered liquidity crunch.

Gold Still Struggles to Fully Shine

And as for the recent collapse in gold, while some will watch for a market bottom and exploit a rebound in the precious metal, many weaker speculators will be shaken away and look for other places to for their investments.

These trends were loudly punctuated by the June 19 and 20 market implosions in international equities and fixed-income investments.

Investors who had sought shelter in conservative bonds after being burned by the collapse of the dot-com bubble in 2000, and then by the 2007-’09 stock-market collapse, realized that fixed-income valuations can be a two-way street.

But right now, not only are equities trading at beaten-down prices, but so are the Exchange-Traded Funds that represent them. And that’s …

Where the Real Opportunity Lies

These trends are graphically driven home in the adjoining table of flows of ETFs with the largest redemptions and creations for the month ended June 20.

In the top portion of the table, you’ll see that all sectors of bond funds were hammered. Five of the eight ETFs suffering the worst redemptions were of the fixed-income variety, including:

  • iShares iBoxx $ Investment Grade Corp Bond (LQD)
  • iShares Barclays TIPS Bond (TIP)
  • iShares iBoxx $ High-Yield Corporate Bond (HYG)
  • iShares Barclays 3-7 Year Treasury Bond (IEI)
  • ProShares Ultra 7-10 Year Treasury (UST)

Maturity-wise, these bond funds were short-term in nature, ranging from three to seven years on up.

In risk exposure, investors dumped everything from high-yield vehicles to what some have considered ultra-safe Treasury Inflation Protection Securities (TIPS).

Two of the ETFs suffering major deflations were emerging-market vehicles – including the iShares MSCI Emerging Markets Index (EEM), which topped the list of outflows — joined by a cousin in the gold sector, the SPDR Gold Trust (GLD).

A Quick Note About Redemptions

ETF redemptions and portfolio creations are not the result of investors “buying” and “redeeming” shares, as with open-end mutual funds. Investors buy and sell shares to others in open markets on exchanges.

Net changes in valuations result from somewhat-complex arbitrage operations by “authorized participants” — usually specialist firms.

Where is All This Money Going?

The money fleeing bonds, emerging markets and gold has to go somewhere. The ETFs that attracted more than $1 billion are listed on the bottom of the above table.

They include a pair of Russell 2000 mid-cap equity funds — the iShares Russell 2000 (IWM) and the ProShares Ultra Russell 2000 (UWM) — possibly recipients of proceeds from former emerging market enthusiasts.

In addition, with autos in a replacement cycle, the iShares MSCI Germany ETF (EWG) attracted assets, as Germany is home to VW, Mercedes and BMW.

Finally, with financials often gaining some dominance as an economic expansion matures, the Financial Select Sector SPDR (XLF) also attracted assets.

ETFs holders generally represent a more financially sophisticated population of investors than those who put their savings into vehicles such as open-end mutual funds, 401(k) plans and IRAs.

And so, as money increasingly flows out of fixed income, the inflow of cash into dividend-paying equities should gain momentum.

A Coming Wake-Up Call …

In just few days, month- and quarter-end statements fall into the hands of bond investors. Many will be jolted for the first time by the realization that those anemic-yield vehicles they took refuge in can actually fall in value. Sometimes quite dramatically!

With prices of bonds heading lower, the alternative for disenchanted fixed-income fund investors might be to seek refuge in money-market instruments with returns so close to zero that their rewards, after inflation, would be negative.

So, as seems to already be happening with ETF holders, you can expect throngs of depressed bond investors to abandon their nests.

As I have said in this space before, “bond-beater” equities are likely to appeal to these returnees to the stock market. At Global Trend Trader, I keep a lookout for stocks with competitive dividend yields that are likely to grow along with advancing earnings.

In fact, I regularly run a software routine I developed that searches U.S. and international stocks for “bond-beater” candidates to add to the Global Trend Trader model portfolio.

Funds from disenchanted bond-holders can only help the wounded stock market. Although there is still no way to tell if it will be enough to repair all the recent damage, this is a trend we can likely expect to take us into year-end and beyond.

Best wishes,

Rudy

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