With few exceptions, most Exchange Traded Funds (ETFs) have done very well so far in 2019. For investors who took advantage of the opportunity in ETFs that follow the S&P 500 or similar large-cap stock indexes, this has rung especially true.
From the beginning of the year through the market close on April 23rd, the S&P 500 has risen nearly 17%. Most stock ETFs have tracked that performance closely. In fact, the first quarter of 2019 was the best first-quarter return for the S&P 500 of the last 21 years.
These gains would be hard to complain about if it weren’t for the fact that they just got us back to breakeven after the big drop last October-December. However, I think fund investors have cause to look forward to a continuation of the trends we have seen so far that could make the rest of 2019 a good year for ETFs.
What ETFs have done the best?
As I mentioned, ETFs that track large capitalization stocks like the S&P 500 or Dow Jones Industrial Average have done the best so far in 2019. The ETF that experienced the most growth in total investors was the Vanguard S&P 500 ETF (VOO) that saw investors place another $6.5 billion in the fund over the last 4 months.
Tracking right behind large-cap stock ETFs were those that invest in the stocks of emerging markets (EM) like Brazil, Russia, China and India. This is a little surprising, because investors are still concerned about trade disputes and tariff wars between the U.S. and China. But because EM funds are considered riskier than large cap funds, investors like the fact that they have been rising together. The correlation between risky and “safe” stock funds indicates that there is more strength behind the bull market than if large cap funds had been rising alone.
Adding a little more confidence to the rally is the group of ETFs representing corporate bonds. The outperformance of this group is a little less surprising than EM because investors have been very attracted to the relatively high dividends paid by these ETFs. For example, if you include the value of its dividends, the iShares High Yield Corporate Bond ETF (HYG) is up almost 8.5% this year, which is very good for a bond fund. For comparison, the Bloomberg Barclay's Aggregate Index, which tracks the performance of corporate bonds in the U.S. is only up 2.5% for the year.
The outlook for the top performers in 2019
A preference for large-cap stock and corporate bond ETFs is easier to understand if you know what the U.S. Federal Reserve (the Fed) has been promising about interest rates. If you have been shopping for a mortgage, you probably already know that rates have declined since the end of 2018 and are currently near the same level they were in January of last year.
If interest rates are low, investors tend to favor “income” over growth. Dividends are more valuable while rates are low, and the Fed has promised to resist raising rates again in 2019. Large cap stocks and corporate bonds are sources of income, so investors have favored those funds.
Because economic growth is a little slow right now and the Fed has promised (more or less) not to raise rates again this year, I expect these trends to continue. We may not get another 17% worth of gains in a 90-day period, but I think the preference for income will help large-cap and corporate bond funds outperform.
Which ETFs have done the worst?
The big bullish move in stocks in 2019 indicates that investors were willing to take on more risk and may have oversold the stock market at the end of 2018. Even though funds with large dividends performed well, investors haven’t seemed very worried about adding “safety” funds to their portfolio.
For example, if investors start to panic, they will buy funds that track things like gold or U.S. Treasury bonds. These assets don’t pay much, if any, income and they aren’t usually expected to grow; however, they are usually safer than stocks in a bad market.
The largest ETF that tracks gold-bullion, the SPDR Gold Shares ETF (GLD), is down nearly -1% for the year so far. The largest ETF that tracks long-term U.S. Treasury bonds, the iShares 20+Year Treasury Bond ETF (TLT), is only up a measly +0.67% for the year.
The healthcare sector is another group that tends to do better in a slow market and has been performing poorly this year. In this case, the negative returns from ETFs that track healthcare stocks is more likely the result of political uncertainty around the “Medicare-for-all” ideas promoted by 2020 Democratic presidential candidates than a bullish market.
The outlook for the worst performers in 2019
The poor performance in safety assets like gold and U.S. Treasury bonds tells us something about the market’s bias in 2019. If interest rates are low and economic growth is still positive, investors are likely to avoid the most conservative investments. I expect that this trend will continue, as long as there aren’t any major economic disruptions later this year. For example, if growth in China and India were to drop suddenly, the safety sectors could get a lot more interest from investors.
The current trends among ETFs seem likely to continue if economic growth remains positive overall. I have some concerns about whether that situation can be sustained into 2020, but, for 2019, the trends we have seen so far seem likely to continue. Investors should continue to prefer stock funds and higher-risk corporate bonds funds while interest rates remain low.