The Top Three Moments That Moved ETF Markets in 2023

The aftermath of the 2022 bond bear market

Last year brought a dramatic shift in the conventional wisdom surrounding bonds as a tool for diversifying away from equity risk. This change was largely driven by the Federal Reserve's aggressive monetary policy actions.

Beginning in March 2022, the Fed embarked on a series of 11 rate hikes, aiming to curb inflationary pressures. This aggressive stance on interest rates had a profound impact on the bond market.

Throughout 2022, the bond market experienced a significant downturn. The iShares Core U.S. Aggregate Bond ETF (AGG), a widely followed barometer for the U.S. bond market, encapsulated this trend. AGG saw its value decrease by 13.03% over the year, even after accounting for reinvested distributions.

However, the most significant blow was dealt to investors in the iShares 20+ Year Treasury Bond ETF (TLT). TLT, which attracts investors attempting to capitalize on potential market bottoms, recorded a staggering loss of 31.24% in 2022.

This negative trend extended into 2023, with TLT further declining by 5.67% year-to-date as of November 30, 2023. In contrast, AGG recovered somewhat, returning 1.89% as of the same date, but still lagged short-term Treasury bill ETFs like the iShares 0-3 Month Treasury Bond ETF (SGOV).

Despite these setbacks, there has been a renewed interest in TLT as the Federal Reserve again paused its rate hikes. Investors have now channelled $1.88 billion of inflows into TLT over the last month, betting on a potential rate cuts in 2024. Given TLT's high duration – a measure of sensitivity to interest rate changes – any reduction in rates could lead to substantial upside for the ETF.

The regional banking crisis

The crisis of 2023 began in March with the contagion and failure of multiple regional banks, marking a tumultuous period for the sector.

The downfall started with Silvergate Bank. Following the collapse of crypto exchange FTX, Silvergate faced a bank run due to concerns over its crypto-related deposits. As the bank struggled to meet withdrawal requests, it began selling assets at a loss, leading to its voluntary liquidation in March 2023.

Then Silicon Valley Bank, serving the technology industry, faced similar issues. The bank experienced significant mark-to-market losses on its fixed-income portfolio due to the Fed's interest rate hikes. An ensuing bank run led to its seizure and placement under FDIC receivership.

Finally, First Republic Bank faced a sharp decline in its stock value, leading to a massive withdrawal of uninsured deposits by panicked clients. Despite a significant capital infusion from major banks like JPMorgan, the bank was eventually closed and sold to JPMorgan by the FDIC.

In response to these failures, U.S. federal bank regulators announced extraordinary measures to backstop and ensure all deposits at Silicon Valley Bank and Signature Bank would be honored.

Regional bank ETFs like the SPDR S&P Regional Banking ETF (KRE) and the iShares U.S. Regional Banks ETF (IAT) have not fully recovered from these events, with both still down approximately 20% year to date as of November 30th.

In contrast, the broader financial sector ETFs, such as the Financial Select Sector SPDR Fund (XLF), which hold a higher allocation to large banks due to their market-cap-weighted nature, have fared better. XLF, for instance, is showing a positive year-to-date return of 6.44% as of the same date.

The "Magnificent Seven" bull run

On a positive note, for investors, especially those with a focus on large-cap growth stocks from the technology, consumer discretionary, and communications sectors, was the impressive performance of a handful of stocks this year.

The financial media has christened these companies – Apple, Amazon, Tesla, Nvidia, Microsoft, Meta, and Alphabet – as the "Magnificent Seven," the new FAANG cohort for 2023.

This group's outperformance had notable implications for ETF investors. Comparing the SPDR S&P 500 Top 50 ETF (XLG), the SPDR S&P 500 ETF Trust (SPY), and the Invesco S&P 500 Equal Weight ETF (RSP) as of November 30th, there were significant differences.

XLG, thanks to its heavy weighting in these seven companies, all of which rank in the top 10, returned 33.74% YTD. SPY also benefited from its market-cap-weighted approach to the S&P 500, posting a 20.68% return.

However, the story was different for the other 493 S&P 500 stocks – RSP lagged significantly, returning just 6.44%. This divergence has not gone unnoticed by contrarian investors, who have moved approximately $1.89 billion in inflows to RSP in the month preceding December 12.

ETF issuers are also responding to this trend. For example, Roundhill Investments has renamed their big technology ETF BIGT to the Roundhill Magnificent Seven ETF (MAGS) to capitalize on investor interest in these dominant companies.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.