Rotation whiplash sends US$2.8 billion cycling through small caps

[NEW YORK] The latest head fake in the rotation trade left exchange-traded fund (ETF) investors flat-flooted.

News of a potential coronavirus vaccine breakthrough sent a combined US$1.8 billion into the iShares Russell 2000 ETF (ticker IWM) at the start of the week, with Tuesday's US$1.55 billion haul clocking in as the fund's biggest inflow since 2018, according to Bloomberg data.

Then over US$1 billion exited IWM over the following two days as US cases spiked and fears of further restrictions grew.

The whiplash continued Friday, with IWM rising 1.4 per cent to outperform a 0.2 per cent gain for the tech-heavy Invesco QQQ Trust Series 1 (QQQ).

IWM is set to best QQQ by 7.3 per cent this week despite its mid-week stumble, the largest outperformance since April.

The back-and-forth flows speak to the difficulty investors face in navigating the competing currents - a potential end to the pandemic and a broad reopening, versus how long it will take to see vaccines distributed and the remaining economic pain.

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In the ETF market, it's clear that focus quickly turned to the latter scenario, with signs of economic activity slowing even before cities from Chicago to Minneapolis to New York reinstated restrictions this week.

"You're seeing the debate on Covid and the stock market playing out before our eyes," said Michael Cuggino, president and portfolio manager at Permanent Portfolio Family of Funds.

"Due to a vaccine, maybe the end is in sight, so stocks go up big. Then that news is tempered by case numbers and potential shutdown talk."

Small-cap and value shares surged to start the week, with the Russell 2000 Index outperforming the Nasdaq 100 by the most since 2002 on Monday.

But that rotation quickly fizzled as investors rushed back into the so-called stay-at-home trade, boosting megacap tech stocks.

The change of heart was evident across ETFs. On Monday, the US$1.6 billion SPDR S&P Regional Banking ETF (ticker KRE) absorbed the most cash since March as climbing US Treasury yields boosted bank stocks, only to bleed cash for the next three days.

QQQ posted a US$1.4 billion outflow on Tuesday, followed by cumulative inflows of US$608 million the following two days.

"Because the market is so catalyst driven, there's going to be volatility in this rotation depending on Covid headlines," said Tom Essaye, a former Merrill Lynch trader who founded "The Sevens Report" newsletter.

BLOOMBERG