ETFs: Investors favor ‘traditional sector rotation plays’ in 2022, strategist says

Dave Nadig, CIO and Director of Research for ETF Trends, joins Yahoo Finance Live to discuss sector ETF outlooks, investing in cyclical sectors like energy and financials, gold, cryptocurrency, the Fed, inflation, and the geopolitical tensions between Russia and Ukraine.

Video Transcript

- And we are going to switch gears now. It's time for the "ETF Report" brought to you by Invesco QQQ. It's been a rocky run for markets lately and here to discuss how investors can position themselves amid all the volatility is Dave Nadig, ETF Trends CIO and Director of Research. Dave, Thanks so much for being here. So last year was a record year for inflow into ETFs. This year is starting off on very shaky ground. Do you see the same sort of inflow this year? And if so, which sectors look safer than others at this point?

DAVE NADIG: Yeah, I mean, I don't think we're necessarily in the bag to beat last year's $900 billion in inflows. It a nearly a 2X on the previous record. However, flows have been very strong so far this year already and they've been very strong into equities, despite what we've seen in the markets. One of the things that's been most interesting to me is how much attention sector funds themselves have gotten. Sector funds largely got forgotten by investors over the last couple of years in favor of thematic ETFs, things like ARKK.

But what we've seen just already this year is a lot of interest in traditional sector rotation plays. Financials, energy, and staples are the three that I would highlight. Jared was just talking about XLE and the run it's had. It's pulled in a $1.5 billion already this year, XLF has pulled in $2 billion by itself, and XLP, the staples ETF, also another $1.5 billion. So what we're seeing is really classic rotations into both inflation and rising rates plays. And I think financials is probably the place to look the tightest.

Financials was the third best performing sector last year. It's the best performing sector so far this year among the ones that are not labeled energy. So I think it's very interesting to think about why folks are rotating in there. Financials are often tricky to time around interest rate hikes. We know we're heading into them, but that balance between the curve shifting and rates coming up can be very tricky, especially as a lot of banks are coming off of a very, very strong 2021.

ALEXIS CHRISTOFOROUS: Yeah, good point. And, I mean, you mentioned XLF, Dave. For investors looking for an alternative to that, where else can they look, maybe where there isn't as much exposure to those mega-cap financial stocks?

DAVE NADIG: Yeah, so XLF is a fine ETF that owns the 69 financials firms that are in the S&P 500. It's very heavily dominated by the likes of Berkshire Hathaway, Citi, you know, JP Morgan, Bank of America, all in there with very large positions. If you want to look a little less mega-cap, I like the equal weighted strategy here. It would be the Invesco RYF. If it's an equal-weighted basket of the exact same stocks that you'd find in XLF. If it is a little bit more expensive, but it actually beat by a decent amount last year during that big run up that we had.

And if you are looking for a more traditional cap-weighted exposure, I also like Fidelity's approach here. It's FNCL tracks the MSCI version of a financials index. It adds a whole lot more names. You're getting almost 400 securities in there. That helps dilute some of that exposure to those mega-cap names. You're also getting it on the cheap. It's only eight basis points.

- And then I'm wondering how you're looking at gold, because it's getting a lot of attention from people at this moment.

DAVE NADIG: Yeah, gold was a terrible trade all last year and investors pulled their money out all year. I mean, billions and billions flowed out. So far this year, that's completely reversed. GLD, the gold ETF, is the highest gaining asset gathering ETF so far this year. Obviously, that's folks rotating into gold as a safety play here. For folks who are using Bitcoin for that, obviously gold looked like a slightly better play here. The caveat I would put is that this has turned out to be hot money.

GLD is not a place people are actually parking money for the long term anymore. It may have used to have been that. Now it's a trading vehicle for getting short-term exposure to bullion. So I wouldn't read into that, that somehow the entire market is running to safety. What I would read into that is people are nervous and they're looking to stay invested in something and they don't like the US dollar sitting in a bank account.

ALEXIS CHRISTOFOROUS: Dave, we've got some breaking news on the geopolitical tensions here between Russia and Ukraine. So we've got "The Wall Street Journal" reporting that the US military has ordered several hundred troops on standby to potentially deploy to Eastern Europe. If we see military action there occur, what happens to inflows into ETFs? Are you already seeing some jockeying for position?

DAVE NADIG: I mean, I think that's a lot of what we've seen already for the last two weeks. The general nervousness about being invested in risk assets as a bucket, I think the geopolitical tensions are absolutely there. I think they're also a little unknown. Remember that Ukraine is one of those places where we had some on and off again news over the last five years, but it hasn't been quite the predictable nature of what we've seen, perhaps even in the South China Sea or in the Persian Gulf.

Ukraine is a little bit more unknown territory as far as US politics is concerned, so I would be paying close attention to there. I personally think the risks of any kind of hot war are very de minimis and I expect calmer heads to prevail. That being said, recognize everybody else is watching the same news you are and it's real easy to hit the sell button when you're feeling nervous.

- OK, that is very true indeed. We will have to leave it there. Dave Nadig, ETF Trends CIO and Director of Research, thanks so much for your time and insight today.