FTSE Russell, CME Group and iShares look at what’s driving US equity markets

Sarah Rudolph

Sarah Rudolph

Editor-in-Chief

The 2020 rollercoaster continues in equities markets, and investors are turning to a variety of investment products to hedge and diversify, according to speakers at FTSE Russell’s webinar titled, “What’s been driving US equity markets outperformance?” on Thursday. 

US equities outperformed international stocks this year and gained the most since June, when the rest of the market rally was losing steam.

Mark Barnes, FTSE Russell’s Head of Investment Research, Americas noted U.S. equity markets hit all-time highs in February after COVID hit in China, but that was before the virus was understood. They then hit lows in March, and the smaller cap Russell 2000 dropped further than the Russell 1000 in that period, 

In equities, both momentum and quality stocks did well in general in 2020, and value and small-size stocks underperformed, he said. However, quality stocks in the Russell 2000 did not do well, which was an outlier.

Tech stocks dominate the R1000 and healthcare dominates the R2000, Barnes said, and both sectors did well, with smaller healthcare companies doing better than larger ones. Energy was hurt in the first quarter, and banks  “really got knocked down in Q1,” Barnes said. 

The two biggest risks investors saw in 2020 were valuation risk and COVID-19 risk. But “momentum has been paying off,” he said. “Stocks that did well continue to do well.”  He added that overall valuations remain high, especially in Europe.

Many of these trends are expected to continue. What could change is, of course, the COVID crisis – with the arrival or the delay of vaccines and treatments, or the possible arrival of mutations or further waves of infection, Barnes said.

The “elephant in the room” is the elections, he said. There, “the 2020 shocks and surprises are not over.”  Investors want to be able to quickly adjust their portfolios. 

FTSE Russell and the CME Group entered into a licensing agreement in 2015 and CME Group now offers a variety of futures, options on futures and OTC cleared products based on the FTSE Russell indexes. Tim McCourt of CME Group said the volatility backdrop will continue into Q4 and 2021, and this should mean continued investor interest in hedging and managing risk exposure with indexes. 

“There are five mechanisms to manage risk exposure,” McCourt said, “futures, OTC swaps, options, and ETFs. But often it’s not an either/or decision. Using equity indexes such as the Russell 1000 and 2000 allows you to move between risk pools seamlessly.”

A cash basket is often the best way to replicate an index, but ETFs are a product choice that offers more security, he added.  Investors are increasingly moving between cash baskets, ETFs and futures to take advantage of whichever product works best at any given time.

The CME’s partnership with FTSE Russell has grown over the years, and recently they have introduced several new products, including total return futures, micro emini futures, and TACO (Trade At Cash Open).

The emini Russell 2000 futures and options have been a  success story, McCourt said. E-mini Russell 2000 futures have averaged 215,000 contracts per day in 2020 (or $15 billion in notional value) RTY futures and options had record quarterly ADV in Q1-2020 at 228,000 and 3,000, respectively.

The E-mini Russell 1000 at CME continues to grow in open interest as well. ADV since launch has been  around 400 contracts, with a monthly record ADV of 1,400 in June 2018.

Another way to move between ETF or cash and futures is by doing an exchange-for-physical or a bilateral transaction, McCourt added. The trick is looking to optimize your index exposure. The CME Russell products give investors the opportunity to freely convert between investment vehicles without outright price exposure, he said.

Kristy Akullian, CFA of iShares Americas at BlackRock, said that what we learned about trading from the COVID crisis and ensuing volatility is that ETFs can act as a shock absorber in the market and absorb  excess trading that happens along with volatility. She  emphasized that ETFs are not just a retail vehicle – there is also demand for ETFs from institutions. 

ETF trading booms in periods of volatility, Akullian said, and the ETF share of total trading has jumped as well. In 2019, ETFs made up about 20% of total equity trading. 

“When uncertainty rises, people turn to ETFs, because everyone else is turning to them as well,” she said. “They are very important in terms of liquidity provision.”

Akullian expects volatility to continue into 2021. 

She said she sees the market as positioning for a Biden win and even maybe a wider “blue wave.”  

“There is a very pronounced preference for fixed income within an ETF wrapper,” Akullian said. “YTD we’ve seen bond ETFs taking in about $2 billion, twice as much as domestic equities.”

One interesting demographic detail is that retail investors who are very active in the market tend to prefer single stocks. “Only a handful [of trades in Robinhood] were ETFs – most were single names,” she said. The older cohort of investors prefers fixed income.

She also said equities may be under-owned and a fair amount of cash sitting on the sidelines. $1.6 trillion has gone into money market funds, she noted. 

“Investors load up on bonds and cash at the start of an election year and then rebalance into equities and when the election is over,” she added.

Market flows are showing a rotation into small caps, which outperformed throughout October, she said, possibly on expectation of further stimulus. 

She echoed McCourt in saying that it’s “not an either/or between ETFs and various derivatives. People are trading both.”  “One big takeaway in investor behavior in index product usage is in the way investors think about portfolio construction – adding a buffer or liquid ETF or futures around a single stock,” Akullian said. 

“Liquidity is not something you need to diversify,” she said. “Investors are willing to take on lots of types of products to diversify risk in case the liquidity gravitates away from one of them.”

 

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