ETFs & Markets with Todd Sohn: Flows, Sectors, and the Leveraged ETF Boom

So, where do we stand on equity ETF flows? We've finally started to see a pause in demand for equity ETFs over the last two weeks.

This is a chart of the average weekly flows to equity ETFs, with the x-axis showing the trading weeks of the year. We're about 16 weeks into the year, and the last two weeks have shown a noticeable slowdown as stocks have rallied—likely reflecting some caution about how sustainable this rally is.

We actually don’t mind seeing a slowdown in equity ETF demand. It suggests sentiment is cooling at these levels.

That’s especially evident at the sector level, where, since the peak over two months ago, we've seen inflows only into the utilities sector, while all other sectors have experienced outflows. Notably, tech has meaningfully cooled.

Over the past three months, tech sector ETFs have seen the largest outflows in two years. That signals a meaningful shift in investor sentiment toward tech. Also toward the bottom of this list are energy and financials. Energy has struggled over the last couple of months, and we view the drop in financials as more of a mean reversion after the "sugar high" post-election in late 2024.

So, with no strong conviction at the sector level and total equity flows cooling down, we view that as constructive for the broader sentiment backdrop—especially when paired with very pessimistic investor surveys. Now, the key question is: Do we have enough underlying demand for stocks to push through the current corrective phase? That remains to be seen.

If you’ve had a conversation with us this year, it’s likely touched on the leveraged ETF space, which has grown very popular very quickly—across both retail and institutional demand. This is one of our favorite charts. It compares assets in leveraged long ETFs versus inverse ETFs.

At the start of this year, that ratio was about 12 to 1 in favor of leveraged long strategies—the highest in our dataset. This is still a relatively young category, really emerging about 15 to 20 years ago and becoming more popular post-2020. So, we thought that level was excessive.

Following the recent correction, the ratio dropped to about 4 to 1 and now sits around 7 to 1 as of the end of April. What we struggle with here is that at the market lows in 2020 and 2022, the ratio fell to around 1 to 1—basically equal asset levels on both sides. We're not quite there yet. The question is whether 7 to 1 is the new norm or just an outlier. I don’t have the answer, but it’s something to keep in mind, especially as markets continue shifting toward these types of products. You can also see this in the flow data.

Whenever the market pulls back, there’s typically a surge in flows to leveraged long ETFs. That might reflect a “buy the dip” mentality or attempts to press bets when the market appears to be on sale. Recently, flows into leveraged long products have really picked up—perhaps a little extreme for our liking, but it does indicate conviction.

That said, I would caution everyone: these products involve a lot of risk. Leveraged ETFs are not necessarily meant to be buy-and-hold strategies for the long term.

Here’s one example using the Nasdaq 100 with 3x leverage. It’s worked out if you've been able to stomach the volatility over the last 15 years.

But that's also during a period when stocks were in a structural bull market. That’s not the same as the 1970s or 2000–2009, which were more sideways markets.

So here are three key points to consider if someone asks, “Why not just buy and hold leveraged ETFs for the long run?”

1. Can you stomach the drawdowns? These products can experience 70%, 80%, even 90% drawdowns at times.
2. Your selling point needs to line up with good timing. If you need cash and you’re in a 50% drawdown, that’s a problem.
3. Stocks must avoid a secular bear market. For example, while U.S. tech stocks have done well, applying leverage to emerging markets has often led to significant losses because those markets have experienced a secular bear market.

So, just something to keep in mind if anyone asks about using leveraged strategies in their portfolios.

That’s what we have for today. Equity flows have cooled down over the last few weeks—and that’s okay. Lack of conviction at the sector level is interesting, and we’ll be watching closely to see what re-emerges as leadership following this correction. As for leverage, there’s a lot of risk there, but also interesting sentiment signals we like to track.

We've seen a decent reset, though we wouldn’t mind seeing a bit more from the ratio of leveraged long to inverse ETF assets. Let us know if you have any questions.

This communication was prepared by Strategas (“we,” “us,” or “our”), a brand that offers investment advisory services through Strategas Asset Management, LLC, an SEC Registered Investment Adviser, and provides research to institutional investors through Strategas Securities, LLC, a broker-dealer and FINRA member firm and an SEC Registered Investment Adviser.  This communication represents our views as of 10/08/2024, which are subject to change, and presented for illustrative purposes only. The information contained herein has been obtained from sources we believe to be reliable, but no guarantee of accuracy can be made. This communication is provided for informational purposes only and should not be construed as an offer, recommendation, nor solicitation to buy or sell any specific security, strategy, or investment product.  This communication does not constitute, nor should it be regarded as, investment research or a research report or securities recommendation and it does not provide information reasonably sufficient upon which to base an investment decision. This is not a complete analysis of every material fact regarding any company, industry, or security. Additional analysis would be required to make an investment decision. This communication is not based on the investment objectives, strategies, goals, financial circumstances, needs or risk tolerance of any particular client and is not presented as suitable to any other particular client. Past performance does not guarantee future results. All investments carry some level of risk, including loss of principal.

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