Investors embraced risky assets in November — hoping the Federal Reserve is done hiking rates. And some of the best ETFs and mutual funds for stocks and bonds shined.
Interest rates fell substantially during the month. The 10-year U.S. Treasury yield lost 51 basis points, ending the month at 4.37%. The bond markets as well as stocks rallied.
"November's been a very good time for risk assets," said Brian Levitt, global market strategist at Invesco. "It's a market that has become increasingly enthused that inflation is in the rearview mirror, that the Federal Reserve is done raising interest rates and it's an economy that's remained resilient even 18 months after the beginning of tightenings."
He added that the current market is believing in a soft economic landing. And that has led to a broader participation of sectors such as small caps and value.
Soft Landing Coming For Best ETFs
Cathie Wood's ARK Innovation was the best fund on the month with a 31.4% return. The $8.4 billion ETF is also among the top performers this year, with Fidelity Blue Chip Growth raking in the biggest gain of 49.9%.
U.S. diversified stock funds rose an average 8.5% in November, for a yearly gain of 12.6%, according to Refinitiv Lipper data. Equity leverage funds outperformed, advancing 19.5% and 32.6% for the month and the year, respectively.
"I think we're in the midst of (a soft-landing) right now," said Jim Caron, chief investment officer of the portfolio solutions group at Morgan Stanley Investment Management. A soft landing includes "cooling growth, maybe a minor recession and right now, what we're seeing is fourth-quarter growth is likely to be somewhere around 1.5% GDP. Third-quarter growth, annualized, was 5.2% as far as the latest revisions go. So, we see a cooling growth, not a collapse. It has all the earmarks of a soft landing."
More importantly, he added, "we're getting this decline in inflation without a major spike in the unemployment rate. That is a very important point to make."
Girding For The Economy's Twists
Economic models usually require more significant damage to the job market. But in the current environment, inflation is coming down without seeing that. This underscores the soft-landing scenario.
As such, Caron believes growth sectors still offer good returns. He also likes industrials and materials, as well as the energy sector which has been underinvested in. He's less bullish on the consumer discretionary and telecom sectors.
The best sector funds in November were global and U.S. science/technology, financial services, consumer services, precious metals equity and real estate. They returned between 10% and 15%. So far this year, science and technology funds lead the pack with a 40% gain.
Among the best sector ETFs in November were again two of Cathie Wood's funds: ARK Fintech Innovation and ARK Next Generation Internet, surging around 30%. They're up over 64% this year.
Other strong performers in 2023 are MicroSectors FANG+ ETN and VanEck Semiconductor, up between 58% and 85%.
Best ETFs Preparing For The First Quarter
Invesco's Levitt believes, however, the risk-on, soft-landing scenario will last through the first quarter of 2024. After that and into the second and third quarters of next year, the market might slow down. At that point, investors might benefit from shifting into higher-quality, low-volatility stocks. Nevertheless, he does not see a recession in 2024.
"Once you've gotten past peak inflation, peak tightening and peak interest rates, markets historically have done well over the subsequent one, two and three years," he said. This doesn't mean that the (interest rate) cycle won't end at some point and that the higher interest rates will finally result in an adverse effect on the economy, he added. But it does suggest that we will experience a risk-on environment "until we see otherwise."
He expects small caps to outperform large caps while the yield curve normalizes. That might take a few years as the Fed starts to ease rates.
Going International
On the international front, he sees some pickup in the manufacturing sector. Emerging markets and even global developed markets could provide some opportunities, especially as the dollar starts to ease.
"We would favor international investing over the next few years," said Levitt. "That's one of the surprises that investors might be in for."
World stock funds rose an average 8.4% in November for a yearly gain of 10%. The top performers were Latin American, European region and international small and midcap growth funds, jumping upward of 10% last month.
Among the best ETFs this year are WisdomTree Japan Hedged Equity, Global X MSCI Greece and iShares MSCI Poland, up more than 40% through November.
"We tend to be overweight Japan," said Morgan Stanley's Caron. "We think that there's a lot of improvements in corporate governance, returning money to shareholders. There's nominal growth in Japan, which is coming from more stable inflation close to 2%, which is a direct driver of earnings. So we think the earnings trajectory is good."
Is Stagflation Coming In Europe?
He's more cautious on European equities, however, and believes the continent could enter a stagflationary period. This is a situation where growth is stagnating or declining while inflation is increasing. European fixed income is attractive, though.
While government and corporate bonds rallied in November, Charles Tan, senior vice president and co-chief investment officer of global fixed income at American Century Investments, believes we could be heading toward a harder landing and a deeper recession than the markets are pricing in. He says the effect of higher interest rates is starting to show in the economy.
"If you think about interest rates (10-year U.S. Treasury yield) coming down from 5% to 4%, that rallies the market," he said. "But when the rates start to go from 4% to 3%, that tells you this economy is going to a different phase." In such a scenario, the economy would be sliding into a harder landing. This harder landing could be about six to nine months out, he says.
Searching For Yield By Best ETFs
Last month saw a strong performance across most bond areas. High yield and high yield municipal debt funds did especially well, returning between 4% and 6%. Emerging markets local and hard-currency debt, as well as global income funds also rallied.
In this environment, Tan is pursuing a barbell strategy. On the front-end of the yield curve, investors can get high yields without incurring excessive interest rate or credit risk. For example, American Century Multisector Floating Income yields 6.4%, carries nearly no interest-rate risk, and charges 0.27% in annual fees.
For the long-end strategy, Tan has been adding duration (when interest rates fall, bond prices rise with longer duration).
American Century Multisector Income is a high-quality, actively managed bond ETF yielding 6.3%. It has a duration of 5.24 and one of the lowest fees among peers of 0.36%. It is up 5% this year.
