Best Stock Funds Struggle Amid Inflation, Covid Woes; Bond Funds Gain

The stock market took a turn for the worse in the last days of November, suffering a sell-off after the discovery of a new coronavirus variant and the Federal Reserve’s more hawkish tone on inflation. Due to increased volatility, many of the best mutual funds and ETFs gave up their prior gains and then some, though most are still up for the year on strong earnings.


The third quarter delivered another strong earnings season, but the trend is toward normalization, says Tony DeSpirito, chief investment officer of U.S. fundamental equities at BlackRock.

“Revenue growth of nearly 18% and earnings growth approaching 40% were strong absolute numbers, but earnings surprise is moderating,” said DeSpirito. “Beats on both revenue and EPS in the third quarter, while still above the five-year average, were below what we’ve seen in the prior four quarters. We expect company earnings to remain strong as pent-up demand is satisfied. But there is less room to overdeliver.”

An increase in Covid cases, especially in Europe, and a broadening of the inflationary base were some of the negative factors in November, said Johan Grahn, head of ETF strategy at Allianz Investment Management. Despite this, the stock market took the information in stride for most of the month.

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Best Mutual Funds And ETFs Navigate Choppy Waters

But the announcement of the omicron Covid variant on Thanksgiving and the Fed’s acknowledgment of inflation running into next year sent risk assets into a sell-off.

“Amid already heightened uncertainty, markets navigated through choppy waters again (on Nov. 30) as Chairman Powell’s commentary course-corrected the view on inflation and the potential need for quicker policy adjustment,” said Charlie Ripley, senior investment strategist for Allianz Investment Management.

The only major index to post a mildly positive return was the Nasdaq, up 0.33%. The Dow sank 3.73% and the S&P 500 fell 0.7% in November. Some of the best mutual funds and ETFs declined as a result.

U.S. diversified equity funds gave up 2.65% on average, trimming their YTD returns to 16.79%, according to Refinitiv Lipper data. Most fund categories were down, with small and midcap growth funds among the worst performers. Small and midcap value, as well as S&P 500 funds, are among the best mutual funds for the year, up more than 22%.

Sector Funds Post Declines in November

Sector mutual funds declined across the board, with agriculture, precious metals, science and technology suffering the least. International funds painted a similar picture.

Among the best U.S. diversified ETFs were tech and S&P 500 growth funds. Invesco QQQ Trust (QQQ), Invesco Nasdaq 100 (QQQM), iShares Russell Top 200 Growth (IWY) and SPDR Portfolio S&P 500 Growth (SPYG) rose 1.5% to 2% in November. They’re up 26%-plus this year.

Top sector ETFs also included technology funds as supply-chain bottlenecks fueled price increases. IShares Semiconductor (SOXX), VanEck Semiconductor (SMH), SPDR S&P Semiconductor (XSD) and Defiance 5G Next Gen Connectivity (FIVG) were top-performing ETFs in November, surging from 6.1% to 11.5%. They have returned between 20% and 40% so far this year. Foreign funds declined across the board.

“If you’re worried about an increase in rates and you’re worried about equities, as long as there is value in companies, they’re growing and we have a positive GDP, the equity risk premium should be out there,” said Allianz’s Grahn. “The problem with the equity risk premium is that it’s volatile. And if you can’t stomach the volatility or if you’re close to retirement and you can’t really afford to have a big drop in the value of your portfolio, then you have a double whammy of dropping equity markets and inflation.”

Best Mutual Funds And ETFs Held Back By Inflation, Covid

Buffered outcome ETFs such as AllianzIM US Large Cap Buffer20 Jan (AZBJ) provide equity exposure while placing a cap on the downside in case of a market sell-off.

The U.S. 10-year Treasury yield plunged 16 basis points on Black Friday — the largest one-day fall since the beginning of Covid-19 in March 2020. It ended the month at 1.43%, down 12 basis points.

“Bond markets are on edge right now. With a new Covid variant and potential changes in monetary policy expectations, we’ve seen rate volatility increase lately,” said LPL Financial fixed-income strategist Lawrence Gillum. “And these concerns are being exacerbated by poor liquidity in the Treasury market. Unfortunately, that means we’re likely to continue to see elevated levels of volatility in the near term.”

Most bond funds ended November with positive returns as rates dropped across the yield curve. Some of the best ETFs included PIMCO 15+ Year US TIPS (LTPZ), PIMCO 25+ Year Zero Coupon US Treasuries (ZROZ) and Vanguard Extended Duration Treasuries (EDV), surging 3.6% to 4.3%. LTPZ is up 7.53% for the year, while ZROZ and EDV are still down.

Bond Funds Play Catch-Up

“The reality is that hotter inflation coupled with a strong economic backdrop could end the Fed’s bond buying program as early as the first quarter of next year,” said Ripley. “Ultimately, the transitory view on inflation has officially come to an end. Powell’s comments reinforced the notion that elevated prices are likely to persist well into next year. With potential changes in policy on the horizon, market participants should expect additional market volatility in this uncharted territory.”

Within the commodities space, funds that held up the best were related to carbon credits. The iPath Series B Carbon ETN (GRN) and KraneShares Global Carbon (KRBN) surged 29.15% and 17.09%, respectively. They’re up 132.82% and 94.19% this year.

Carbon credits were designed to allow companies to meet their carbon emissions goals in case of delays or in areas that needed offsetting. Carbon neutrality has gained strong support from governments and investors in recent years (see this month’s ETF Picks story).

Going forward, financial experts project more volatility in the markets, which could affect some of the best mutual funds and ETFs.

“Buckle up, this will be a December to remember,” said John McClain, portfolio manager at Brandywine Global. “We are seeing a somewhat similar backdrop to 2018, with interest-rate hikes being priced into the market and a faster taper combined with rich equity valuations and limited liquidity. The market can be driven by fundamentals, technicals and momentum, and at this point it’s a bit of all three.”

Barbell Strategy With Cyclicals On One End And Tech On The Other

From an investment standpoint, DeSpirito still favors a barbell strategy. That includes cyclical stocks on the one hand — such as financials, banks and energy — and more stable, higher-quality compounders on the other — such as technology and health care.

Kari Montanus, senior portfolio manager at Columbia Threadneedle Investments, believes that inflation is longer than transitory but not necessarily runaway  hyperinflation. “We think that growth is stronger for longer and inflation will last longer than the market is thinking,” she said. “We’re eventually going to decelerate back to trend in economic growth because of demographics and the deflationary forces in our economy.”

Montanus is also lead manager on Columbia Select Mid Cap Value (CMUAX). The $2.6 billion mutual fund focuses on niche midcap value firms and includes those that have the power to pass higher materials prices to customers.

Examples include Capri Holdings (CPRI), which markets luxury brands Versace and Jimmy Choo, and exploration and production firm Devon Energy (DVN). Devon was one of the first to implement a variable-dividend structure, where the company pays out any excess free cash from higher oil prices to shareholders.

Another long-term holding is chipmaker Marvel Technology (MRVL), a successful transformative story since Columbia bought it in 2018.


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