Stock markets started 2023 with a bang, as major indexes posted solid gains in January. Some of the best ETFs and mutual funds racked up double-digit returns.
Bond funds also did well as the 10-year U.S. Treasury yield declined 36 basis points to end the month at 3.52%. However, the yield curve, which measures yields for various maturities, inverted further. This means that long-term yields were lower than short-term yields, usually a predictor of an upcoming recession.
"There (were) two major happenings in the market (in January)," said Bill Callahan, investment strategist at Schroders. "Inflation is still relatively elevated, but it is coming down. And longer-term interest rates are following that down." This is not only great for fixed income markets, but also for risk assets such as equities.
Among the major stock indexes, the Nasdaq composite soared 10.72%, S&P 500 advanced 6.28% and Dow rose 2.83%. International stocks also did well, with MSCI EAFE jumping 6.3%.
Market's Mood Improves For The Best ETFs
The second thing was a turn in sentiment, attitude and price within equity markets, Callahan said. "You're starting to see people think about taking on more risk. We've seen some of the risk-on sectors of the market perk up a little bit."
U.S. diversified equity funds surged an average 7.25% in January, according to Refinitiv Lipper data. Among the best mutual funds were equity leverage, up 18.22%, and small-cap value, up 9.5%.
Riskier sectors outperformed, with global science/technology, global financial services, U.S. science and technology, consumer services and telecommunication funds posting double-digit returns. Basic materials, real estate and precious metals equity funds also did well as the best ETFs and mutual funds. Defensive sectors lagged.
Among the best diversified stock ETFs with double-digit returns were ARK Innovation, soaring 27.82%, Invesco S&P 500 High Beta, up 16.16% and Renaissance IPO, advancing 15.9%.
Tech Stocks Perk Up
Within sector ETFs, seven posted 20%-plus returns. The top three were ARK Fintech Innovation, ARK Next Generation Internet and ProShares Online Retail — up between 27% and 29%.
"One thing that's been really interesting in the market so far in January, it's been the strength in tech," said John Porter, chief investment officer of equities at Newton Investment Management. "I caution people not to anchor on the year-to-date number — you have to remember that the month of December was just a really, really tough month for tech."
He sees some disappointment in the earnings of the semiconductor and software space. He believes more work remains to be done on the fundamental side of the tech business for those companies to become attractive again.
Going Beyond The U.S. For The Best ETFs
International funds outperformed U.S. stocks, with world stock funds jumping an average 8.33% in January. China benefited as it reopened from Covid restrictions, with China region funds adding 11.5%. Other strong performers among the best mutual funds were Latin American, Pacific Ex-Japan and global multi-cap growth funds, with 9%-plus returns.
The best international ETFs in January were Invesco Golden Dragon China, iShares MSCI Mexico and Main Thematic Innovation, sporting 16%-plus returns.
Inflation is the center of the discussion in the markets, said Porter. In addition, earnings expectations have been coming down for a while.
And, "I still think too many investors are expecting a Federal Reserve pivot, in other words that the Fed will start cutting before the end of this calendar year," he added. "That just seems like a highly unlikely scenario."
All of these elements combined, Porter said it's "a tough recipe for stocks." He advises caution.
Prospecting In The Sectors
Within sectors, Porter still likes energy and health care, especially biotech. With the China reopening, he expects higher demand for the energy sector.
"Health care is the right balance," he said. "With all the uncertainty in the market right now, if things go poorly, there's some really strong and stable businesses within health care. The valuations in general are pretty attractive."
In addition, the pace of innovation and disruption has really accelerated over the last two or three years in the biotech sector, he said. The resulting products will begin to make a difference in people's lives and change the business fundamentals around biotech, and this will "really start to become a reality in 2023 and 2024."
Schroders' Callahan said that their base case is that the U.S. goes into a recession: "We don't think we're going to be spared from that."
Note The Rotation Among Best ETFs
Meanwhile, he believes the markets are undergoing a major rotation. Within the U.S., he's more positive on cyclicals, as well as small caps as opposed to large caps. Globally, he likes international and emerging markets stocks.
"It's been a long time since we've seen (international) stocks do well relative to the U.S.," Callahan said. "What's interesting is last year they outperformed the U.S. and it was probably the most uncovered story ever. They're outperforming so far this year."
A weaker dollar, China reopening, the worst of the energy crisis being avoided in Europe are among the factors that provide a tailwind for international stocks. "There's a lot of factors that were very negative for international and emerging markets last year, that are starting to ease off," he said. "Given that the markets were priced for the worst-case scenario, things don't have to be great there for these markets to do OK. They just have to muddle through."
On the bond front, things also picked up in January. General domestic taxable funds gained 3.19%, with flexible income, general U.S. Treasury, as well as corporate debt A and BBB-rated funds racking up 4%-plus returns.
Among the best bond ETFs were Virtus InfraCap US Preferred Stock, Invesco Preferred and Invesco Financial Preferred, with 12%-plus returns.
Where's The Momentum Now?
"We had a lot of momentum finishing off 2022," said Steve Laipply, U.S. head of iShares fixed income ETFs at BlackRock. "With the worst bond market in 40 years, we still in the U.S. raised over $100 billion in fixed income iShares (in 2022), and that trend is continuing very strongly, because so far this month, we've raised about $15 billion."
The big theme that's driving the flows is that yields haven't been at these (high) levels in many years. "Investors are using fixed income to de-risk their portfolios," he explained. "Meaning, now if you get above 4% on, for example, two-year Treasuries, you don't have to take so much risk in your portfolio to get in a certain yield target."
Laipply said we'll continue to see a lot of opportunities in the bond markets. He especially likes longer-dated investment-grade bonds, mortgages and some emerging markets debt.
ETFs that are representative of his view are: iShares 1-5 Year Investment Grade Corporate Bond, iShares iBoxx $ Investment Grade Corporate Bond, iShares 20+ Year Treasury Bond BuyWrite Strategy, iShares iBoxx $ High Yield Corporate Bond and iShares JP Morgan USD Emerging Markets Bond.
"It's a really attractive time to reallocate back into fixed income," said Laipply. "We think there are a lot of opportunities. It's a great way to be able to hit your yield targets well while reducing your level of risk."
