In the past few weeks, volatility has returned to the markets. The bond market seems spooked by the concept of inflation, the gold and equities markets seem to be de-leveraging. Valuations are contracting in growth sectors and factors seem to be rotating. All that being said, the world looks very different from a year ago, but the uncertainty of the future is still driving the volatility. On March 11th of 2020, the ETF Think Tank published “Another Article about Coronavirus”. The fear, loathing and reality of the pandemic was setting in, but the fire-sale in markets had not yet fully materialized. Today’s uncertainty is based on the unclear return to normalcy, while digesting one last stimulus check (shot in the arm). Transitions are always jarring, perhaps the bond market is simultaneously acknowledging the pain of reopening inflation, while discounting the potential growth of the roaring 2020s.
Do the Same Rules Apply?
In 2020, the markets were rocked early on by the realization that the bulk of our economy would have to shut down in response to the pandemic. After the initial liquidity crash in mid-March, we saw unprecedented stimulus and the hyper-adoption of mega-trends like contactless payments, Gig economy companies, online retail, telemedicine and many other technologies. The recent bond market volatility seems to have caused a valuation contraction and market downturn in these high-flying growth stocks. This deleveraging seems to imply a very simple trade: sell the mega-trends and buy the former zombies (oil and airline stocks).
Not that Simple
Through the end of February, the ETF industry highlighted this admiration for mega-trend investing as indicated by both asset growth and performance. Most of the trends are captured by thematic ETFs and, more precisely, by active thematic ETFs. Based on the ETF Think Tank security master, there are 198 thematic equity ETFs with about $168 billion in assets. About 20% of thematic ETFs are actively managed, but those funds control about 33% of the assets. The 40 active thematic ETFs were up 12.7% on average through February 28th. That said, the performance of this group was severely wounded last week during the initial zombie rotation. The point is that growth is messy. The reopening will be inflationary and underestimated. The over-reaction will be the mirror opposite of the fire-sales from spring 2020. However, the genie is out of the bottle on these mega-trends and the rotation will not be simple. Within the ETF industry, active managers are now tasked with capturing the benefits of these trends in the reopening; we would not discount their potential success.
Bloomberg provided a great illustration of the phenomenon we described above with thematic ETFs.
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