The stock market broadened its sell-off in June, sending most major indexes into bear territory. Few areas of the market remained untouched. Many of the best mutual funds and ETFs gave up a big chunk of their year-to-date gains.
Despite the Federal Reserve's 75 basis point rate hike to contain inflation, a slowing economy sparked fears of a recession. The 10-year U.S. Treasury yield ended the month up 13 basis points at 2.98% after hitting 3.5% by mid-June just before the Fed's rate increase.
Both the Nasdaq and the S&P 500 saw spectacular declines of over 8% in June. The Dow shed 6.7%. All three indexes were down 22.28%, 16.1% and 11.25%, respectively, in the second quarter. This year they're each down 29.23%, 20% and 15.31%.
Back-To-Back Down Quarters
We have "back-to-back down quarters for stocks and bonds, which is very unusual," said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management. "To have the first half of the year (for) both stocks and bonds down for both quarters — that's only happened four times since 1976. So, it's been an unusually poor performance."
U.S. diversified equity funds fell an average of 8% during the month, for a loss of 15.3% and 20% in the second quarter and this year, respectively, according to Refinitiv Lipper data. Equity leverage, as well as midcap and small-cap value funds were among the worst performers.
Most Sectors Down
Most sector funds fell. Among the best mutual funds from May, natural resources, commodities base metals, basic materials and precious metals equity sank over 14% in June. For the quarter and the year, nearly all funds, except for energy, are down.
Other sectors that underperformed were consumer services, global and U.S. financial services, as well as global and U.S. science and technology funds, shedding 10% on the month.
"The market's kind of searching for a bottom here that's really not going to be found, I fear, until we get more tangible signs that inflation has indeed peaked," said Grohowski. "We've got really the worst of both worlds happening, which is continuing concerns about inflation but growing concerns about recession. And so that translates into one word: stagflation. And that's a very bad word for investors."
Best ETFs Hard To Find
Among the best ETFs, pickings were slim. Within foreign stock ETFs, China funds were the best performers. Global X MSCI China Consumer Discretionary, Invesco Golden Dragon China and KraneShares Bosera MSCI China A 50 Connect Index surged between 13% and 16% in June. The funds are still down on the year.
Most bond funds also declined. General domestic taxable funds lost an average of 3.47% in June, with high yield funds seeing the biggest declines. They were down 6.51% in the second quarter and 10.2% year to date. Short/intermediate investment grade also did poorly, shedding an average of 1.52% last month. They're in the red for the quarter and the year.
Best ETFs For Bonds
A top bond ETF was Simplify Interest Rate Hedge. The $300 million fund was up 3.29% in June and has soared 50.5% this year. It provides a hedge against rising interest rates with the use of interest rate options. It charges 0.5% in annual fees.
Regarding the sell-off in stocks and bonds, Christopher Huemmer, senior investment strategist for FlexShares ETFs at Northern Trust Asset Management, says that this is going to continue.
"Stock and bond correlations are different in inflationary environments than they are in deflationary environments," he said. "In deflationary environments, equities and bond prices are negatively correlated to one another. Meaning that as interest rates rise, bond prices fall while yields increase. Historically, in deflationary environments, stock prices have also increased."
He explained that in those deflationary periods, central banks raise rates to curtail strong growth, so stock prices go up.
"In inflationary environments, actually we find that stock and bond prices are positively correlated with one another," he pointed out. "Meaning that as interest rates go up, stock prices fall."
In these situations, the Fed is typically raising rates to curtail inflation, "which really puts a hamper in growth, which also hampers stock markets, and so they move down just as bond prices do."
As a result, the typical 60/40 portfolio of stocks and bonds, respectively, only works "in deflationary environment," Huemmer noted. "In inflationary environment, stocks and bonds both sell off, and that's what we've been experiencing this year. That's where other asset classes need to be a part of a portfolio."
Looking At Real Estate For Best ETFs
Huemmer believes real assets that are publicly listed, as well as alternative investments should be key components of a portfolio.
Real assets include energy commodities and equities, natural resources equities, as well as infrastructure. Within infrastructure he likes pipelines, energy utilities, water and waste, railroads, toll roads, airports, seaports, access to water, as well as communications such as owners of fiber-optic cables, data centers, satellites and integrated telecom.
FlexShares STOXX Global Broad Infrastructure Index offers a broad exposure to the infrastructure asset class such as the above, plus government outsourcing like post offices and health care facilities. The $2.5 billion fund is down 7.48% this year and charges an annual fee of 0.47%. Sixty percent of the fund is in global developed markets, with the rest in the U.S.
Hard For Best ETFs To Time This Market
Ryan Issakainen, First Trust Portfolios senior vice president and ETF strategist, says that it's really difficult to time the market: "Although there's certainly some things that investors should be cautious about, I don't think that they can trade around it. I would not recommend anybody to sell out of their equity positions at this time, but you do want to make sure that you're positioned in a way that has more exposure to higher-quality, defensive names."
He particularly likes dividend strategies, which help to replace some income and tend to focus on stocks with higher-quality attributes.
Best ETFs Eye High Quality
"Higher-quality stocks are going to be able to make it to the other side because they've got sustainable business models," he noted.
First Trust Value Line Dividend focuses on dividend-paying high-quality stocks. The $12 billion fund yields 1.9%, charges an annual fee of 0.67% and is down 7.94% this year so far.
Writing covered calls is another strategy Issakainen likes for investors concerned about higher levels of volatility.
IFT Cboe Vest S&P 500 Dividend Aristocrats Target Income strives to provide a fund distribution rate 3% higher than the yield of the S&P 500. The $483 million fund charges 0.75% in annual fees and is down 11.5% this year.
