August was an eventful month for investors. Any hopes of a late summer lull were quickly dashed at the beginning of the month after the publication of disappointing US economic data, together with an interest rate hike by the Bank of Japan, sparked a sharp sell-off across global equity markets. However, by month end, the market had rebounded as investors began to price in more aggressive policy easing by the Federal Reserve (Fed).
What had happened?
A July US ISM manufacturing print that came in well below expectations and a weak July jobs report, which showed the smallest payrolls increase in over three years, fuelled fears about a US recession. Moreover, the unemployment rate’s slight increase to 4.3% was enough to trigger the Sahm Rule, a measure of labour market momentum that has an impressive history as a recessionary indicator.
At the same time, the Bank of Japan’s decision to increase its policy rate by 15 basis points and Governor Ueda’s hawkish tone led to an abrupt unwinding of carry trade positions, which had relied on cheap Japanese yen borrowing costs to buy other higher yielding assets.
Against this backdrop, global equity markets sold off and volatility spiked, while global bonds rallied. The Bloomberg Global Aggregate Index ended up 2.8% over the month as weaker economic data and cooling inflation bolstered the case for a September Fed rate cut.
However, the equity market sell-off was short lived. After the initial spike in market volatility investors took comfort in the prospect of lower interest rates, as well as a solid Q2 earnings season that showed few signs of an imminent economic slowdown. This allowed most markets to recover their losses by the middle of the month and developed market equities closed 2.7% higher by month end.
What did the market environment mean for active ETFs?
This increase in market volatility once again highlighted the role active alpha can play in a world of heightened policy and geopolitical uncertainty, where greater return dispersion is expected across assets. This view was displayed in the flow data for August. While overall UCITS ETF inflows decreased slightly month-on-month, active ETFs saw their highest monthly net flows with $2.1 billion in August. It appeared investors were waiting for cheaper entry levels and chose active ETFs over passive peers to capitalise on the opportunities in the market following the sharp sell-off.
Preference for core asset classes in active ETFs
Digging deeper into the flow data for August, it’s clear that investors took the opportunity to enhance their core allocations with active ETF strategies. 80% of active UCITS ETF flows ($1.6 billion) went into equities, with a strong bias towards global developed market equities ($878 million) and US equities ($680 million). Active fixed income ETFs saw $366 million in inflows, with 85% going into corporate bond ETFs.
Rising demand for J.P. Morgan Asset Management active ETFs
As the largest active UCITS ETF provider, J.P. Morgan Asset Management benefitted from the increased demand for active ETFs, seeing a net $1.4 billion of inflows into our active ETF range in August 2024. The top three active ETFs that saw inflows were the Research Enhanced Index ETFs for global equities (JREG) and US equities (JREU), as well as the equity premium income ETF (JEPG).
Navigating the volatile market
Fears about an imminent US recession appear exaggerated given the resilience of consumption and a labour market that is cooling, but not collapsing. With inflation retreating, the Fed is on track to deliver several rate cuts this year, starting in September. However, any further weakening of the labour market might warrant a more aggressive policy response.
As long as the earnings outlook is stable, equities should be supported by falling US yields. Defensives and modestly priced quality stocks look attractive in a slowing growth backdrop. As the Fed embarks on a rate cutting cycle, the dollar looks vulnerable because of a narrowing interest rate differential. US dollar hedged strategies and greater international diversification can mitigate this risk for investors. While a soft landing scenario is still our base case, extending out of cash and locking in current yields in high quality fixed income is an attractive way to increase portfolio resilience against the recent market volatility and a negative growth shock.