ETF Investors Underexposed as Stocks Flirt With Bull Market

U.S. stocks are on the cusp of a milestone: The S&P 500 is nearly 20% off its October lows.  

As of this writing, the index is trading at 4,295, or 20.1% above last year’s low point of 3,577. That’s a milestone, because many investors use 20% as the threshold for marking shifts in the market environment—from bull market to bear market (and vice versa). 

Last summer, when the S&P 500 dropped 20% from its all-time high (set in January 2022), headlines blared how the market had fallen into a bear market.  

Now it’s the reverse, with the market knocking on the door of a bull market.  

Unexpected  

Confirmation of a bull market would come as a shock to many who had expected U.S. stocks to tumble as inflation and interest rates soared. 

When the S&P 500 fell by more than 20% last summer, Wall Street prognosticators were calling for an even deeper decline. The consensus was for the U.S. economy to fall into a recession, which would weigh on corporate profits and stock prices. 

The consensus was certainly right about one thing. Profits for S&P 500 companies have fallen for two straight quarters through 1Q 2023, and they’re expected to fall again this quarter. 

But the U.S. economy has remained resilient in the face of steep rate hikes, and there is growing hope that the economy could avoid a recession altogether. 

That possibility may be what’s driving the S&P 500 higher.  

Underexposed  

The S&P 500’s ascent to the door of a bull market is certainly positive for most investors. The three biggest ETFs, including the SPDR S&P 500 ETF Trust (SPY), the iShares Core S&P 500 ETF (IVV) and the Vanguard 500 Index Fund ETF (VOO), track the index. 

But ETF investors may not be benefiting from the rally as much as they’d like. Inflows for U.S. equity ETFs have totaled a relatively modest $22.2 billion so far this year, which compares to $101 billion and $181.5 billion at the same time in 2022 and 2021. 

Bearish sentiment and rising yields on fixed income investments like Treasuries may be why ETF investors have largely shunned stock funds this year. 

Investors have put $685 billion into money market funds so far in 2023, while billions more have entered Treasury ETFs. The iShares 20+ Year Treasury Bond ETF (TLT) is this year’s top asset gatherer among U.S.-listed ETFs, with inflows of $10.7 billion. 

No Guarantees  

While certainly encouraging, the S&P 500 potential shift into a bull market doesn’t provide any guarantees about where it’s headed from here.  

After all, when the index fell by 20% last summer, many investors and analysts feared it could go down a lot more, but it only fell a few percentage points more for a peak-to-trough drawdown of 25.4%.  

Likewise, it’s certainly possible that the current rally in the S&P 500 could extend just a few percentage points more before the index rolls over and heads to new lows.  

Anything is possible; bull markets and bear markets (and the arbitrary rules we use to measure them) are labels meant to help investors categorize and understand different market environments, but they don’t necessarily have any predictive powers. 

Past bull markets have lasted anywhere from three months to over a decade.  

This one, if it’s confirmed, is around eight months old.  

Contact Sumit Roy at [email protected]