The month of May put investors through the wringer again, but select areas of the market did well, boosting some of the best mutual funds and ETFs.
May wiped away any leftover gains from the prior month. That sent the tech-heavy Nasdaq composite into bear territory down 1.93% for a year-to-date loss of 22.53%. A bear market means a decline of 20% or more from a recent high. The S&P 500 and the Dow Jones posted mild gains of 0.18% and 0.04%, respectively. They're down 12.76% and 9.21% each this year.
The Federal Reserve hiked the Fed funds rate by another 50 basis points, sending short-term rates higher. The 10-year U.S. Treasury yield ticked down slightly, ending the month at 2.85%.
"Everything this year has been a mixed bag in terms of performance," said Will Rhind, founder and CEO at GraniteShares. Markets rallied the last week of May, which was a positive surprise for the month.
"The question is are we going to be able to hold that rally, or is it just another dead cat bounce?" he said. "I do think that we should be able to build on some momentum at this level because the market's sold off."
Growth For Certain Mutual Funds And ETFs
U.S. diversified equity funds slid an average of 0.07% in May for a yearly loss of 13.17%, according to Refinitiv Lipper. Among the best mutual funds were small, multi, mid and large-cap value funds, surging upward of 2% during the month. However, they're down between 3% and 5% this year. Equity income funds also did well in May. Growth funds were the big underperformers during the month and many are down more than 20% on the year.
Within sectors, natural resources, commodities, energy, global natural resources and utility mutual funds surged between 4% and 14%. Natural resources and energy funds have returned more than 50% this year as a result of soaring energy prices and geopolitical upheaval.
"The flows in May continue to reflect a bit of (risk management) and defensiveness," said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors. "Equity (ETF) flows were roughly $38 billion. While a healthy rebound from the prior month, that is still well below historical averages. At the same time, fixed income (ETF) flows were well above historical averages. They were $34 billion, which is almost near records."
Dividend ETFs were among the best funds in May. First Trust Dorsey Wright Focus 5, First Trust Morningstar Dividend Leaders and WisdomTree US High Dividend were the top three U.S. diversified stock ETFs in May, surging around 6%.
Mutual Fund And ETFs Endure May
"Dividend funds (ETFs) have seen the most flows ever last month," said Bartolini. "And we saw low-volatility funds take in their fourth-most ever last month."
That said, overall flows are not only below historical trends in magnitude, "but the depth of flows is really low."
In May, only about 52% of funds had inflows. "Historically, 54% of funds have inflows on a given month," Bartolini explained. This points to a below-average participation. "So that really says in May not only investors (reduced risk), but many have just stopped allocating capital for the moment and are really hesitant to make a move amid all of this action."
Oil and gas funds were strong performers. Among the best sector ETFs were Invesco Dynamic Energy Exploration & Production, First Trust Natural Gas and iShares US Oil & Gas Exploration & Production, surging upward 17% during the month and scoring 60%-plus returns YTD.
As to which areas of the market should do well this year, GraniteShare's Rhind thinks "the story of this year will continue, so that's commodities, including gold." He said their strong performance will continue as long as energy and food prices remain elevated.
He also said that it's an opportunity to look at sectors that have been the worst or badly beaten up this year: "For the most part that would be the technology sector." Rhind stressed that it's paramount to look at quality names. Those provide free cash flow, a strong balance sheet and profitability.
Possible Recession Or Contraction?
Rhind doesn't expect a recession this year, but if inflation stays at this level, we could have a contraction next year.
If investors were to expect a similar inflationary environment as in the 70s, gold might be an asset to protect against capital erosion.
"Gold has proved consistently over time to be a store of value," Rhind explained. That's because "the price of gold has maintained its purchasing power, because the supply is relatively constant and it is exchangeable into any currency. The price of gold moves independently so is seen as uncorrelated to the stock market. If the stock market is going down and the bond market is going down, where do you put your money? Gold is one of the best options as it is an asset of the highest quality that has no credit or counterparty risk."
GraniteShares Bloomberg Commodity Broad Strategy No K-1 holds 23 of the largest, most-liquid commodities in the world. The $400 million fund's top holdings include gold, natural gas, oil, corn, soybeans, copper, silver and aluminum futures. Each sector is limited to a maximum of one-third of the fund. The ETF is up over 35% this year. The fund charges an annual fee of 0.25%.
High Bond Inflows
On the fixed income front, general domestic taxable bond mutual funds lost an average of 0.37% during the month for a total decline of 7% this year so far. Short-term bond, investment-grade and GNMA funds are the only ones that posted positive returns in May. Emerging markets local-currency debt funds also did well.
"May's $34 billion of bond inflows ranks second all-time and is three times greater than bond funds' historical median level," noted SSGA's Bartolini in a report. "The significant revival of bonds over stocks stems from a lack of risk-taking by investors amid this uptick in action and cross-asset volatility."
The best bond ETFs were Invesco Financial Preferred, Invesco Preferred and SPDR ICE Preferred Securities, surging 4% or more. They're still down on the year, however.
For the year, the big winners are Simplify Interest Rate Hedge up 46%, and FolioBeyond Rising Rates up 29%.
"May has mostly been about the market being in seek and destroy mode," said Chris Brown, head of securitized products and portfolio manager in the fixed income division at T. Rowe Price. "The market seems to be taking out the parts of the market that had, up to that point, done relatively well."
Has Interest Rate Volatility Topped Out?
In the credit space, lower-quality underperformed high-quality credit. High yield underperformed investment grade, and "within high yield, you saw really for the first time of the year CCC high-yield meaningfully underperforming higher parts of the capital structure."
Even bank loans, which had been Wall Street darlings up to that point due to their floating-rate nature, "for the first time in a long time, you actually saw outflows coming out of bank loan funds."
There is a glimmer of light, however.
"We've started to see some sort of an inflection in markets," said Brown. "In the middle of the month, we've started to see interest-rate volatility top out. And at this point, I think you can make the statement that it is on a downtrend."
He also pointed to signs that inflation is topping out on a directional basis, "and the market took that pretty well." In addition, long-term inflation expectations have been trending down.
"These are all positives for generalized market volatility," added Brown.
That said, it's paramount to see inflation data confirm that we're indeed moving in the right direction, especially for the long-term outlook.
For people who have cash on the sidelines, it might be a good time to "dip your toes" in some credit and securitized markets, noted Brown. "I think fixed income is a much safer place to be in right now."
He said that a lot of the Fed rate hikes and hawkishness is already priced in.
"And very importantly, we've seen a resumption of the historical correlation between Treasurys and equities," he added. "So, on big down days in equities, you've actually seen U.S. Treasurys rally — I think that's what you'd expect and I think it's a healthy development."
