'Plowhorse economy' ambled along despite some negative news; how much upside room is left?
After the spectacular run-up in 2013, investors cautiously continued to bid up the market in the first quarter of 2014. Many pundits, however, forecasted a consolidation within the equity market and foretold of gloom and doom, making references to market-charting similarities between the Dow Jones Industrial Average of 1929 and 2014. Nonetheless, the average equity exchange-traded fund (up 2.18%) outpaced its conventional mutual fund cohort (1.47%), as well as the Dow (0.83%) and the S&P 500 (0.69%) for the quarter. For the seventh consecutive quarter, equity ETFs posted plus-side returns.
While much of the news during the quarter showed an economic softening attributed to the strong winter storms in the U.S. this year, others showed a picture of a “plowhorse” economy continuing to amble along. Despite the conflicting news, investors were treated in March to relatively good news: February's nonfarm payrolls number (+175,000) beat the consensus estimate of 145,000, retail sales increased 0.3%, and industrial production rose 0.6% — surpassing analysts' expectation of a gain of 0.2%. While February new- and existing-home sales disappointed, durable goods orders increased 2.2% and personal income and personal consumption both increased in February, matching analyst expectations.
Perhaps the biggest story for the first quarter, just nudging out the curtailing of the monetary stimulus by the Federal Reserve, was Russia's unexpected annexation of the Crimea region of the sovereign nation of Ukraine after civil unrest in Kiev forced its president to flee. Investors began to embrace some safe-haven plays in the face of growing geopolitical uncertainty and on the vacillating economic news.
While markets generally shrugged off the tensions between Russia and Ukraine, especially after the West's muted response to the Crimean vote to secede from Ukraine and rejoin Russia, increased sanctions by the U.S. and Europe led to greater uncertainty, which encouraged investors to take profits from issuers with larger advances. So, it wasn't surprising to see authorized ETF participants turning conservative, injecting approximately $7.5 billion into exchange-traded products during the quarter. However, none of that net amount could be attributed to equity ETFs, which witnessed net outflows of $2.3 billion, while fixed-income ETFs attracted $9.8 billion of net new money. Diversified equity funds suffered the only major redemptions, handing back $5.1 billion during the quarter, while alternatives ETFs (+$2.2 billion), mixed-asset ETFs (+0.5 billion) and commodity ETFs (+$0.2 billion) took in net new money as investors began taking some of their hard-won profits off the table and sought out-of-favor issues and some safe-haven plays.
Lipper's Sector Equity Funds group housed the two top-performing classifications in the equity ETF universe for the quarter, making it the best-performing macro-group of the four broad-based groups for the first quarter since the fourth quarter of 2009. Precious-metals equity ETFs led the way, posting a 13.84% return for the quarter after gold prices jumped 6.78% as investors sought its safety. Commodities agricultural ETFs posted the next strongest return in the ETF universe (+11.72%). The classification benefited from erratic weather in both North America and South America that wreaked havoc on harvests of fruits, coffee and oats and threatened the planting season for soybeans and corn. In addition, a virus outbreak in 22 states in January pushed hog prices to the stratosphere.
Emerging-markets ETFs witnessed some of the worst returns of the equity group. However, India-region ETFs (+9.92%) produced the third-strongest return of the equity ETF classifications. While investors remained concerned over slowing growth in China and Russia's annexation of Crimea, investors' interest in select emerging-markets categories improved late in the quarter — particularly for India-region funds. During the month of March, India stocks rallied as foreign direct investors poured about $2.5 billion net into India's market. There was optimism that the main opposition BJP party might form the next government in the upcoming elections and boost India's policy reforms, which lifted the economy out of its slowdown.
Tom Roseen is head of research services for Lipper Inc.
