Investors who missed the megacap tech rally in the first half finally got their chance in July. Sector participation broadened. This boosted some of the best funds in areas such as natural resources, energy and financial services. The road ahead remains bumpy, however, experts warn.
"A lot of the strategists on Wall Street were bearish throughout the year," said Aaron Dunn, co-head of value equity at Eaton Vance Equity, a part of Morgan Stanley Investment Management. But in July, the bears capitulated, "so there's been a lot of pull into this market. Plus, you had a broader set of returns in July."
Small caps did well in July too as the Russell 2000 led the market with a 6.1% jump. It is up 13.7% this year. The Nasdaq, S&P 500 and Dow gained 4.1%, 3.2% and 3.4%, respectively. They're each up 37.7%, 20.6% and 7.3% this year. Interest rates rose across most maturities with the 10-year U.S. Treasury yield closing in on 4%.
"The market has this view that the Fed's going to start cutting rates when inflation is down," said Dunn. "I just don't share that view, because I don't know why the Fed would cut rates. Labor is sticky, financial markets are doing all right, wages are up and consumers are better able to handle food inflation, maybe fuel inflation again."
What Best Funds See In Rates
Dunn says that after so many years of near-zero interest rates, the Fed finally has a rate structure in place to cut if there's a recession. So he doesn't see the central bank cutting rates unless a recession is confirmed.
"I think it really pays this year to be contrarian," he added. "Because I'm not convinced that we're off to the races in the economy."
As such, owning quality cyclicals has paid off. And he expects those to continue to do well. Cyclicals include health care, pharmaceuticals, energy and financials — sectors that are still catching up with the market.
He also believes active management is a good approach for the best funds to avoid having too much exposure to the top seven megacaps tech names.
Eaton Vance Focused Value Opportunities (EAFVX) is an actively managed fund taking on an opportunistic value approach. It focuses on stocks that provide a high return on capital, have strong balance sheets, low debt and positive free cash flow. A winning management team is also key.
The $277 million fund holds around 30 stocks such as Alphabet, Micron Technology and American International Group. The fund is up over 7% this year, but charges a front load and a yearly expense fee of 0.99%. Calvert Focused Value (CRFAX) has a similar strategy but screens for ESG factors. It's up 7.7% this year.
Best Funds Search For Top Sectors
Among the best sector funds in July were natural resources, financial services and global science and technology funds, scoring between 6.8% and 10.4%, according to Refinitiv Lipper data.
Top sector ETFs included SPDR S&P Oil & Gas Equipment & Services, VanEck Oil Services and SPDR S&P Regional Banking, up 19% or more. Year to date, technology still leads the pack with MicroSectors FANG+ ETN, ARK Next Generation Internet and ARK Fintech Innovation at the top with 70%-plus returns.
U.S. diversified equity funds rose an average of 3.5% during the month, posting 15.7% in yearly gains. ARK Innovation, Renaissance IPO and EA Bridgeway Omni Small-Cap Value jumped 14.3%, 12% and 9.4% each in July. The first two are also among the best U.S. diversified stock funds this year.
More Wild Swings On The Way?
Christopher Huemmer, senior client portfolio manager for FlexShares ETFs at Northern Trust Asset Management, believes more volatility is in the cards.
"While the economic data has been strong, equity markets have continued to move higher in July," Huemmer said. "There's uncertainty and volatility going forward, so how do you still participate in the equity market while this volatility is increasing?"
To lower the risk in an stock portfolio, Huemmer suggests to reduce the stock allocation within the overall asset allocation. Another option is to move to low-volatility stock strategies without changing the stock allocation in the portfolio.
As such, he's underweight stocks. Instead, he prefers real assets such as natural resource stocks as an inflation hedge. As a risk asset, he'd rather invest in high-yield bonds.
"The fundamentals are strong and if you look at how companies have handled their finances, a lot of those in the high yield space have locked in financing prior to the rate increases that we've seen from the Fed," said Huemmer. "So, there isn't a large slug of companies needing to refinance up until you get to 2025. And even looking at 2025, we've seen those issuers that had debt coming due in 2025 have already rolled over that debt."
A fund that follows this strategy is FlexShares High Yield Value-Scored Bond Index Fund. It seeks income diversification while favoring value and quality issuers. The $1.2 billion fund yields over 8% and is up 6.1% this year. It charges an annual fee of 0.37%.
Best Funds Cash In On High Yields
Besides the solid high yield returns this year, some of the best funds for bonds have been Virtus InfraCap US Preferred Stock, First Trust Emerging Markets Local Currency Bond and iShares Convertible Bond. They're up between 14% and 17% year to date.
In addition, investors can earn 5% yields just by owning ultra short-term government bonds.
"We've been really hammering on the benefits of floating-rate Treasurys," said Jeff Weniger, head of equity strategy at WisdomTree.
WisdomTree Floating Rate Treasury yields 5.3% and charges just 0.15% in yearly fees. The fund is up 3.1% this year.
On the international front, foreign stock funds also did well. China region funds jumped an average of 7.8% in July, trimming their year-to-date losses to just 0.5%. Other strong performers were Pacific region and emerging markets funds.
Top ETFs in July were Invesco Golden Dragon China, Global X MSCI China Consumer Discretionary and iShares MSCI Turkey, up 13% or more. For the year, Global X MSCI Greece, iShares MSCI Poland and WisdomTree Japan Hedged Equity are among the best funds, sporting 35%-plus returns.
"We really like Japan," said WisdomTree's Weniger. The yield-curve control move that the Bank of Japan recently implemented hasn't had an adverse effect on Japanese stocks as most of it was already priced in, he explains.
"You have a deep valuation case with some catalysts in that country," he added. "I suspect Japanese equities are much less vulnerable to a (potential) bear market than U.S. equities, if that should end up being the lay of the land."
