The performance of the best ETFs and mutual funds in February screams of a bull market. It also shouts risk-on and brings back memories of powerful past tech stock rallies.
The average U.S. stock fund gained 4.97% in the 29-day leap year February, according to Lipper Refinitiv data. And the supercharged gains, which included outperformance of growth over value, hinted at a broadening out of the rally beyond just the Magnificent Seven megacap tech stocks.
Small-cap growth funds, for example, sprinted ahead 7.41%. Midcap growth rallied 7.31%. And large-cap growth funds jumped 6.84%. The leading sector funds were global science and technology, up 8.18%, and (domestic) science and technology, up 7.91%.
Best February Since 2015 For The Best ETFs
The S&P 500 and Nasdaq had their best months of February since 2015, racing ahead 5.34% and 6.22%, respectively, to reach fresh record highs. Both indexes are up more than 7% in the first two months of 2024.
In contrast, the cash crowd that had fallen in love with risk-free 5% annual yields had to settle for a pedestrian average money market return of 0.40% in February.
Less volatile bond investments disappointed as well. General bond funds fell 0.95% last month and U.S. Treasury funds slipped 1.70% as bond prices fell and yields ticked higher after the Federal Reserve pushed back its timetable for interest rate cuts. Fixed-income investors did see gains in high-yield bond funds, which edged 0.24% higher and loan participation funds like floating rate loans and bank loans, up 0.80%.
AI Lifts The Market
Stocks took flight last month with the help of artificial intelligence, the newest tech innovation to wow Wall Street. February, though, started off with the Fed's buzz-kill message of higher-for-longer interest rates in a push to stamp out inflation. But the month ended with investors tallying up substantial gains, boosted by a Feb. 21 blowout earnings report from leading AI chipmaker Nvidia.
Investors' fascination with AI is propelling markets sharply higher. But the parabolic move of AI stocks is also sending up red flags and concerns that irrational exuberance has returned to Wall Street.
"This (AI rally) really reminds me more and more almost on a daily basis of 1999-2000 when we had a very narrow market and the market was all about technology and everybody thought value (investing) was dead," said Eli Salzmann, manager of Neuberger Berman Large Cap Value fund (NPRTX). "This is not a broad-based rally. I mean, you could call it the Nvidia market. The narrowness of the market makes me very, very cautious."
Back To Rally For The Best ETFs
There's no doubt the stock market is back in go-go mode. ETF performance in February was led by stock funds focusing on growth and quality, momentum strategies, innovation and white-hot sectors like semiconductors and new industries like AI.
February's ETF winners in U.S. diversified stocks included Invesco S&P MidCap Momentum, up 14.49%, Invesco S&P 500 Momentum, up 11.49%, and Innovator IBD 50, up 10.41%.
Among sector ETFs, so-called risk-on sectors also topped the performance charts. VanEck Semiconductor rallied 14.03%. SPDR S&P Biotech rose 12.57%. And Roundhill Magnificent Seven, jumped 12.05%.
And when it comes to ETF styles, growth was the place to be. Vanguard Growth ETF surged 7.07% in February, more than doubling the return of Vanguard Value ETF, which was up 3.34%.
Cathie Wood Under Pressure
In another sign of rising bullish sentiment in February, a pair of aggressive ETFs focused on disruption managed by ARK Invest's Cathie Wood that have come under pressure since racking up huge gains in 2020 during Covid, were among the best performers. ARK Innovation, which began its recovery last year, gained 12.86% in February, trimming its year-to-date loss to 2.14%. Similarly, ARK Next Generation Internet rallied 14.98% to climb back into the black.
So, what's an investor looking at these eye-popping gains to do now? Is it time to get super-aggressive and dive into the hot parts of the market? Or are there other ways to profit?
Top portfolio managers, whose funds were IBD 2023 Best Mutual Funds award winners, have opinions.
A Top Value Fund Manager Sees Value Stock Rebound
Salzmann, manager of Neuberger Berman Large Cap Value, is leery of the tech sector's massive gains. He recalls how white-hot tech stocks back in the dot-com stock era in 1999-2000 eventually went bust. "The hard part for everybody this time is, how long does this parabolic move go?" said Salzmann. At some point, he predicts, tech will falter.
Looking ahead, that's why Salzmann says he's "going against the grain." He expects the "value is dead" narrative will prove incorrect. He sees opportunity in the less-flashy value names, especially if he's right and the economy slows from the lagged effects of Fed rate hikes. "Value stocks are incredibly cheap relative to where many of these (highflying) stocks trade," Salzmann said.
Best ETFs: Time For Value?
The catalyst for value, Salzmann says, might be as simple as capital fleeing the hot corners of the market and moving into the forgotten value space. When market sentiment turns more cautious, money will come out of the highfliers and go into value names with lower valuations and smaller market caps. "Some money will leave the market," said Salzmann. "But there will be enough of a (cash) donation from the growth side where everybody is now concentrated."
Beneficiaries of this capital shift will include financial stocks, including the nation's largest banks. "They are massively out of favor," said Salzmann. He says megabanks, such as JPMorgan Chase, Bank of America and Citigroup, are far less risky today than in the past due to the stricter capital restrictions put in place by regulators since the 2008 financial crisis. If there's a recession, the banks are "going to hold up better than anybody thinks," said Salzmann.
Salzmann is also bullish on defensive sectors of the market over the next 12 to 18 months. "They've thrown out the baby with the bath water," said Salzmann. He likes health care. And he's bullish on consumer staples. In health care, he likes medical equipment makers and pharmaceutical companies. Salzmann couldn't share names, noting that he is aggressively buying. On the staples side, he says large fund holding, Procter & Gamble, is attractive after a big reinvestment phase and smart moves by a new management team. "We think earnings are defiantly going up," said Salzmann.
Why A Top Mutual Fund Manager Is Bullish On Mid-Caps
Dan Mahr, manager of Federated Hermes All Cap Core fund (QIACX), is also leery about the market's concentration in tech and large caps. "It's definitely been a story-driven market," said Mahr. "There's just so much money being thrown at AI right now. Everything looks hunky-dory for now, but it seems to me that it's not going to take a lot (for the trend to reverse). One little breeze could topple the house of cards at some point. So, I think there are a lot of risks out there."
While Mahr does have exposure in the megacap names, he doesn't think the market's largest stocks present the best opportunities now. "There's better opportunities in the midcap space," said Mahr.
Going forward, Mahr thinks earnings will be the main driver of stock prices. One risk, therefore, is if the Fed doesn't deliver a soft landing and the economy goes into recession. Mahr advises investors, especially those saving for longer-term goals like retirement, to "average into well-diversified fund portfolios."
Control Your Risk With Best ETFs
Mahr also says investors should have risk controls in place. He recommends investing in solid earnings with good earnings and cash flow. And he says if a good company falls a lot, say 30% to 40% over a brief period, due to an earnings disappointment, consider buying. "There are going to be opportunities," said Mahr.
Chasing what's hot might not be the safest way to go, adds Mahr.
"Trying to pick a moment to throw money at highflying AI stocks or bitcoin or whatever else is ripping higher on the day is a very risky proposition," Marh said.
Why A Top ETF Manager Recommends A Mix Of Growth And Value Stocks
Making big bets on just growth or just value isn't part of the DNA of JPMorgan Equity Focus ETF. Instead, co-manager Felise Agranoff focuses on both growth stocks and undervalued stocks to generate market-beating returns. No matter what the style, though, quality is a trait that all the fund's holdings have in common. The fund's strategy is a good fit for the current market.
"The beauty of this strategy is that you can combine the really interesting growth companies with some of these really high-quality undervalued franchises," said Agranoff.
Agranoff isn't surprised that the AI-driven tech sector has been in bull market mode. "We're in the relatively early phase of a multiyear spending and investment cycle around technology," said Agranoff. "AI tech spending has become absolutely crucial to every businesses' ability to thrive."
The combination of increased spending on tech, a resilient economy, and a healthy consumer are plusses for the stock market, she says. "We do feel like things are kind of firing on all cylinders," said Agranoff.
Finding High-Octane Stocks
Currently, Agranoff says the fund has been paring back on the fund's "really high-octane growth names" and moving the freed-up capital into quality value stocks. "We've been harvesting a little bit of profits in growth," Agranoff said. "For example, Nvidia, which was once a much bigger bet in the fund, we've taken down and it's a much more modest bet today. We also sold out of Tesla earlier this year."
So, where is Agranoff putting the fund's money now? In stocks and sectors that are more attractively valued. An example is JB Hunt Transport Services, an intermodal transportation company that moves goods via trucks and railroads. The company is reinvesting in its customer service and is also benefiting from a cyclical recovery in the economy. "We believe the company's secular growth will reaccelerate," Agranoff said.
Agranoff also sees value in the out-of-favor real estate sector in names such as retail-focused real estate investment trust Regency Centers and Weyerhaeuser, a timber company that provides lumber to homebuilders. And if oil prices stay higher for longer due to growing demand and headwinds caused by wars overseas, energy names like oil and gas producer EOG Resources could see solid returns, Agranoff says.
Plenty Of Opportunity With Best ETFs
JPMorgan Equity Focus ETF also sees value and opportunity in investment bank Morgan Stanley. "It's one of the premier financial services franchises," said Agranoff. The firm's wealth management business, which helps investors save for things like retirement and college tuition, is a business with consistent growth, says Agranoff. And after a few slow years on Wall Street for IPOs and M&A, business is poised to improve. "We believe the capital markets are reopening," said Agranoff. "There is a lot of pent-up demand."
And when it comes to tech, Agranoff says there are key differences between the 1999-2000 boom and bust and today's tech leaders.
"The biggest difference today is that a lot these tech companies are really high-quality companies with great profit margins and free-cash-flow generation. Nvidia, for example, is being driven by earnings and valuation expansion. And the valuations that we're seeing today don't seem very extreme relative to cash flow."
