Wall Street learns that this year, nothing beat owning the S&P500

'Keep-it-simple'

Handpicking sectors, sheltering in trendy options strategies, going all-in on dividends — none of it has worked as well this year as simply owning the S&P 500.

As 2023 winds down, investors are taking the year’s keep-it-simple lesson to heart.

Amid a 4% rally this month that’s propelled the index’s 2023 advance to 24%, they’ve been pouring money into plain-vanilla stock funds. Equity ETFs have taken in nearly US$69 billion so far in December, the best month of inflows in two years, according to data from Bloomberg Intelligence. They have added more than US$42 billion to the largest fund tracking the S&P 500 — the US$494 billion SPDR S&P 500 ETF Trust (ticker SPY) — putting it on track for the biggest month on record in data going back to 1998.

It’s a testament to what’s worked time and again — buying and holding the benchmark gauge, which is hovering near new highs. Left behind have been a litany of supposedly defensive measures that showed themselves to be something else amid 2023’s upward march: market timing in disguise.

“It’s clear that having a diversified portfolio is probably the best way to navigate the investment climate and the best way to do that is owning the S&P 500 — full stop,” said Art Hogan, chief market strategist at B. Riley Wealth. “If you were to start this year by saying ‘everyone says there’s a recession coming so I’m going to invest defensively,’ you got punched in the nose.”

Coming into the year, many strategists had expected tepid returns following 2022’s battering. But amid signs the economy continued to hold up while inflation slowed, stocks rose steadily throughout the year. The gains were turbocharged in recent days after Federal Reserve Chair Jerome Powell suggested interest rates are likely to come down next year. 

Nothing has slowed the inbound flow of funds — not even in a week that saw the S&P 500 post one of its worst sessions of the year. Despite Wednesday’s 1.5% drop, the index still managed to advance 0.8%, its eighth straight week of gains and the longest streak since 2017.

“It’s aggressive, but it’s also not entirely unexpected,” said Seema Shah, chief global strategist at Principal Asset Management. “As soon as we saw any indication that chair Powell was having a slight shift in stance, that was opening the doors to a huge flood into the equity space.”

A measure of aggregate equity positioning kept by Deutsche Bank AG has been rising in recent weeks, pushing into “overweight territory,” with systematic strategies also raising their stock exposure further above average, wrote a team led by Parag Thatte. Its measure of discretionary positioning has also advanced, likely to the top decile of readings. And alongside massive flows into equity ETFs last week, net call volumes in ETF options rose to the highest in five years, the bank’s data show.

“It’s like we’re almost in a melt-up,” David Kudla, founder of Mainstay Capital Management, said on Bloomberg Radio. “You’ve got professional money managers out there that are lagging their benchmarks — they’re playing catch-up and trying to take advantage of this rally to do that. Retail money is coming off the sidelines because money-market funds were paying such high yields, but now the market is doing so well so we’re seeing that money come into the market.” 

Though equity funds have seen an overall infusion of US$349 billion this year — slightly shy of 2022’s US$398 billion haul — four S&P 500 ETFs have been the recipients of more than a third of the flows, the largest share ever, according to Athanasios Psarofagis, Bloomberg Intelligence ETF analyst. It’s been to the detriment of funds tracking specific sectors like energy and utilities. Sector ETFs have seen outflows of US$12 billion, their worst year on record. 

Those withdrawals proved prescient. Just 31% of “active-like” ETFs — including thematic funds, ESG products, factors and actively managed vehicles — managed to outperform the benchmark index this year, on pace for the lowest beat-rate in data going back to 2014, according to Bloomberg Intelligence. None of the categories tracked by BI had a beat rate of more than 50%.

The success of broad-market indexes masked a rough year for many varieties of tactical investments, particularly those premised on safety. Options-linked ETFs promising extra yield, which entered the year as trader darlings, racked up billions of dollars in inflows but delivered tepid results. The most famous, JPMorgan’s Equity Premium Income ETF (ticker JEPI), gained about 9% on a total-return basis, trailing the S&P by about 17 percentage points.

It was a similar story for ETFs focused on dividend strategies, which raked in more than US$60 billion from defensive-leaning investors in 2022. Dividend-focused ETFs took in just US$1.5 billion this year, one of the lowest hauls on record after most funds missed out on the tech-led rally and underperformed the S&P 500. One of the worst performers is the US$18.8 billion iShares Select Dividend ETF (ticker DVY), which returned just 0.8% after all-in bets on utilities and financial stocks fizzled.

“You look back on this year and say, ‘Why did I even bother to have factor investing or sector-specific investing when had I been in the S&P 500, I would have done much better?’” B. Riley’s Hogan said. “There’s a lot of that reckoning that’s happening.”