The markets continued their treacherous journey through war, sanctions, rising energy costs, higher interest rates, a hawkish Federal Reserve and persistent inflation in March. Despite heightened volatility, some of the best mutual funds and ETFs scored impressive returns, especially in the energy and more defensive sectors.
"Markets got more complicated," said Nanette Abuhoff Jacobson, global investment strategist at Hartford Funds. "2021 was really marked by a single theme and response, which was Covid and what the policy response would be. So, while it didn't feel like things were relatively simple, in hindsight it was. And that's why risk assets did spectacularly well. Now, we've got multiple narratives that are rocking markets and volatility is much higher."
She explained that between the various narratives pulling at the markets, "The markets are having a tough time figuring out across all these cross currents which one is going to dominate when."
Analyzing Market Moves With Best ETFs
U.S. diversified equity funds gained an average 1.53% in March, while the S&P 500, the Nasdaq and the Dow racked up 3.71%, 3.48% and 2.14% gains, respectively. The advances trimmed their year-to-date losses, which nevertheless remain between 5% and 9% for the above funds and indexes.
The 10-year U.S. Treasury yield spiked nearly 50 basis points to end the month at 2.32%. The yield curve, which tracks yields for various maturities of U.S. Treasuries, inverted between the three and the 10-year maturity in March. The three-year yield ended the month at 2.45%, 13 basis points higher than the 10-year yield. An inverted yield curve — when long-term yields are lower than short-term ones — often points to a nearing recession.
Across fixed income, no bond fund came out unscathed as higher rates pushed down the value of bonds. U.S. taxable fixed income funds declined an average 1.54% in March, for a year-to-date loss of 4%. Among the worst performers during the month were general U.S. Treasury funds, down 4.34%. They've declined 8% so far this year. International bond funds also fell.
"While inflation has been an increasing issue for the last year, what Ukraine war did to energy markets, raw materials and agricultural markets, it just accelerated inflationary pressures around the world," said Michael Clarfeld, portfolio manager at ClearBridge Investments, a specialist investment manager of Franklin Templeton.
"And with that, it has led to much higher interest rate expectations amongst investors. So, we've seen big moves in the commodities in the last month and, particularly in the last few days (of March), big moves in interest rates."
Caution Warranted?
He adds that the stock markets had recovered fairly dramatically in the second half of the month, and "We're somewhat surprised by that and think there's still this buy-the-dip mentality out there that comes with being very late into the market cycle. We think caution is the watchword given continued geopolitical unrest, soaring inflation and soaring interest rates."
Clarfeld is co-manager of ClearBridge Dividend Strategy (SOPAX) and ClearBridge MLP and Midstream (CEM) funds.
"I think dividend growth can be a very powerful tool for investors. It's always true, but it's particularly true in an inflationary environment," he added. "Because as we think about seeing our cost of living rise — prices around us going up and how do you maintain your purchasing power — with dividend growth you get growing income that can keep up."
On the ETF front, some funds scored impressive returns. Low-volatility, dividend and large-cap growth funds were among the best U.S. diversified stock ETFs in March. WisdomTree US High Dividend, iShares Core High Dividend and Invesco S&P 500 Pure Value were the top three funds year to date, returning upward of 6.3%. They rose more than 3.5% in March.
Looking At The Best ETFs And Funds
Among the best sector mutual funds were natural resources, commodities general, base metals and energy funds, as well as precious metals equity and utility funds, surging between 8% and 12%. Many are up between 20% and 36% this year.
The best ETFs in sectors included SPDR S&P Oil & Gas Equipment & Services, SPDR S&P Metals and Mining and SPDR S&P Oil & Gas Exploration and Production, soaring between 15.5% and 17%. They're up between 41% and 52% this year so far.
Internationally, Latin America and especially Brazil equity funds, are bringing home 11%-plus returns. So far this year, iShares MSCI Brazil, Franklin FTSE Brazil and iShares Latin America 40 are up over 30%.
Saira Malik, chief investment officer at Nuveen, doesn't believe valuations will be driving the markets. Instead, high single-digit to low double-digit earnings growth could lead to moderately positive equity returns in 2022. That said, this economic growth will be mostly coming from companies with strong pricing power in this inflationary environment.
This includes companies in the energy space, as well as stable tech firms that showcase strong free cash flow, such as Microsoft, Amazon and Google's parent Alphabet. She prefers to avoid areas that are marked by high competition, such as social media. Microsoft is on IBD's Leaderboard list.
The Inflation Wildcard
"Because of what's going on with inflation, if you don't have the ability to raise prices, you're going to have trouble driving your earnings," Malik said.
In the energy sector, she points out the very tight level of supply and a strong demand because of the economic recovery, as well as renewed producer discipline. "Producers are much more disciplined than they've been in the past. They're focusing not only on moderate volume growth, but also on returning cash flow to shareholders."
Malik advises to be more selective within fixed income as this year will prove to be challenging due to rising interest rates. She prefers shorter-duration bonds.
To find yield, she's more positive on emerging markets debt, as well as corporate debt. In addition, Latin America and emerging markets equity may provide opportunities.
U.S. Opportunities For The Best ETFs
Hartford's Jacobson believes there are pockets of opportunities in U.S. equity markets. Those include commodities as well as more defensive areas such as health care and real assets. Metals will be in high demand due to the transition to renewables, as well as agriculture.
"I think base case is we avoid recession," she said. "But the increase in tail risk around inflation, stagflation and recession means that you really need to look at your portfolio and be sure that you've got protection in any of those environments that are not your base case." As such, Treasury inflation-protected securities and even gold could have a place in a portfolio.
Hartford funds that align with the above strategies include Hartford Dividend & Growth (HDGIX), Hartford Schroders Commodity Strategy ETF and Hartford Global Impact (HGXIX).
