Stock markets continued their broadening and rotation trade in February. Small-cap stock funds were among the best ETFs and mutual funds on the month and year to date. Worries of inflationary pressures, however, propelled the 10-year U.S. Treasury yield above 1.50% by month-end, spiking volatility in the markets.
“February was a very interesting month,” said Sinead Colton, deputy chief investment officer and head of equities at BNY Mellon Wealth Management. “We’ve seen a trifecta of optimism. We had the vaccine rollout accelerating in major developed countries. We had, what looked like, additional certainty around the $1.9 trillion stimulus package from the Biden administration. And then, we started to see stronger consumer data.”
Despite the volatility, major stock indexes ended the month with positive returns. The Dow showed the most strength, advancing 3.17% in February, according to Lipper Inc data. The S&P 500 rose 2.76%, while the Nasdaq composite gained 1%. Small caps and value stocks shined, with the S&P 600 Value index surging 10.81%.
Best ETFs And Mutual Funds Could Face Spike In Long-term Rates
Meanwhile, bond funds across the board declined due to a spike in long-term rates.
“The only problem with the move in rates, in our mind, is you don’t want it to be too fast, too sharp, too quick,” said Tony Rodriguez, head of fixed income strategy at Nuveen. “I would argue that where we are now — sub-1.50% (on the 10-year U.S. Treasury yield) — the market should be able to have days of indigestion and volatility related to it, but there will be no negative consequence, broadly speaking, for the markets.”
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U.S. diversified equity funds gained an average of 4.64% in February and are up 4.91% year to date. Small-cap value were the best mutual funds, surging 10.91%, for a yearly gain of 15.03%. Midcap value funds were a close second, with a 8.05% and 8.82% jump, respectively. Large-cap funds lagged, but nevertheless posted positive returns for the month and the year.
Some of the best sector mutual funds included natural resources and commodities energy funds as oil prices rose. These funds surged 19% and 15.6%, respectively, in February. They’re up 24.04% and 22.81% this year. Financial services also did well on a steepening yield curve. They’re up more than 12% for both last month and the year. International stock funds also posted positive returns.
On the fixed-income side, domestic taxable bond funds declined an average of 0.45% last month and also year to date. General U.S. Treasury funds suffered the most, shedding 3.57%. They’re down 5.53% this year. Emerging markets and other international bond funds also sank.
Best U.S. Diversified ETFs Focused On High Beta, Small Cap
“To the extent that the rate increase is driven by positive fundamentals and growth, that is supportive of the broader capital markets,” said Rodriguez. For long U.S. Treasury bond investors, obviously, this could result in negative returns.
The picture was similar on the ETF side. The best U.S. diversified stock ETF last month was Invesco S&P 500 High Beta (SPHB), up 17.70% in February and 18.45% YTD. Year to date, top funds in this category include iShares Micro-Cap (IWC), Pacer U.S. Small Cap Cash Cows 100 (CALF) and Avantis U.S. Small Cap Value (AVUV) — all scoring returns of around 20%.
Cannabis funds were the top performers among sector funds, while oil and energy ETFs outpaced other commodity funds.
China ETFs still dominated the international scene, with KraneShares CSI China Internet (KWEB), Invesco China Technology (CQQQ) among the best foreign ETFs. Other foreign markets also have started to catch up on China, such as the iShares MSCI India Small-Cap (SMIN), ARK Israel Innovative Technology (IZRL) and iShares Taiwan. They’re all up over 10% in February and around 20% YTD.
The combination of positive GDP data, strong earnings growth and improved manufacturing is what makes Sylvia Jablonski, chief investment officer at Defiance ETFs, bullish on the markets regardless of short-term volatility.
Stimulus Could Bolster Best ETFs And Mutual Funds
The expected stimulus “is going to bolster not only the consumer, but also corporate America and the areas of main street that haven’t been able to participate in the recovery,” she said. “There’s so much pent-up demand … people want to spend.” That could also bolster the best ETFs and mutual funds.
In addition, there’s a lot of tech innovation and disruption in the markets, she pointed out. “There are so many cool new opportunities that weren’t there this time last year. We weren’t talking about SPACs, innovative medical companies, electric vehicles and hydrogen. So, there are going to be massive new opportunities, inventions and innovations for people to invest in,” she added.
Defiance 5G Next Gen Connectivity (FIVG) was the first 5G ETF and recently surpassed $1 billion in assets. The fund was up 29.75% last year and has advanced 5.09% this year. Top 10 holdings include NXP Semiconductors (NXPI), Qualcomm (QCOM) and Skyworks Solutions (SWKS).
BNY Mellon’s Colton says that since the 2008 financial crisis, inflation fears have not come to fruition. So, “the factors that have dampened inflation are still there today.”
Demographics, Technology, Expanding Global Supply Chain
She refers to favorable demographics, technology and a more global supply chain. She believes remote working will continue to dampen inflation because “it removes some of the pricing pressures that might have been in the major metropolitan areas.” Also, higher structural unemployment coming out of the pandemic will have to be worked through first, which will extend lower rates for longer.
Areas in equities she expects to do well this year include small caps, developed and emerging markets, especially China, and cyclicals. Within the U.S., she holds a barbell structure of work-from-home and reopening stocks. The former includes technology and financials. The latter — industrials and materials.
“I think the open question is how the economy moving out of the pandemic has changed,” said Colton. She definitely expects equity markets to be bumpy, and possible new lockdowns could be a negative. However, she said that’s to be expected. Therefore, it’s key for investors to remain invested and stay the course.
On the bond side, Nuveen’s Rodriguez advocates diversified portfolios of risk assets. These will not provide the double-digit returns of 2020, but investors could expect low-to-mid single digit returns in that area. He expects U.S. Treasuries to continue to post negative returns.
Steepening Yield Curve Could Effect Duration
Because of a steepening yield curve, he is defensive on duration. Nuveen Floating Rate Income (NFRIX) invests in high-yield floating rate bank loans. This keeps the duration short as rates can reset and keep up with a rising-rate environment. The fund yields over 4% and charges an annual management fee of 1%. It is up 2.3% YTD.
Within credit sectors, Rodriguez recommends holding a mix of investment-grade credit, structured products (such as collateralized loan obligations and commercial mortgages), high yield and emerging markets.
“We’re definitely not pounding the table that there’s one single sector in fixed income that is particularly cheap to all the others,” he said. “We do think valuations have recovered quite a bit and don’t have much more room (for extra performance), particularly in higher-quality and even mid-quality segments. But we don’t advise going into the lowest-quality buckets.”
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