ETFs began 2009 deep in negative territory. Defensive sectors like healthcare, consumer staples and utilities were among the only areas producing hopeful returns, though they remained in the red. But as the S&P 500 climbed nearly 32% over the next three months, ETFs also prevailed. Equity funds performed strongly across the board from March through May, pushing many sectors into double-digit returns for the year.

Among the top performers were technology, up 22.1% year-to-date through the end of May; basic materials, up 28.3%; and consumer discretionary, up 13%. Gold, one of the sole strong performers of the recession, was up 33.8%.

Flows into these sectors were impressive as well. From March to May, basic materials saw a 106% rise in assets, industrials an 84% rise, consumer discretionary a 75% rise and tech, 69%.

SIGN OF RECOVERY?

Some say ETFs' impressive performance since March is a sign of recovery. "The money is flowing to early cycle types of sectors, which is a very bullish sign for the market that maybe we're not too far from turning around," says Dan Dolan, director of wealth management strategies at Select Sector SPDRs.

One sign of an upturn is the rise of the real estate sector, notably commercial REITs. Real estate was up 39% over the three-month period ending May 31, though the sector was still down about 7% for the year through the end of May. And the Ultra Real Estate ProShares fund was still down an abysmal 60.3%.

An impressive three-month run also wasn't enough to pull financials out of their yearly loss. Despite a three-month double-digit rise, the Ultra Financials ProShares fund was still down 56.3% for the year. In fact, some investors began to unwind their ETF positions in financials in exchange for more single-stock exposure, as investors began to trust certain firms again. "We're seeing redemptions, and my guess is that people were buying individual names that were beginning to outperform," Dolan says.

The story in emerging markets is also promising. After investors rushed from these funds in droves, fearing U.S. troubles would spread, China regional and Latin American funds were up 35.9% and 47.9%, respectively. The U.S. diversified emerging-markets category was up 26% year-to-date through the end of May. "These are economies strongly dominated by U.S. exports, so when we sneeze, these guys catch a cold," says Jeff Tjornehoj, a fund analyst at Lipper. "This year, people thought maybe the worst was behind us and that now was a perfect time to get in."

CONSOLIDATION BEGINS

But the news hasn't all been good for ETFs. For years, behemoth companies like iShares and State Street Global Advisors launched several new ETFs each month. At the end of May, 683 ETFs traded domestically, with $521.49 billion in assets. Although 27 new ETFs were launched this year, the consolidation of the industry began too. Forty-five ETFs closed this year, including 19 PowerShares offerings that were shuttered in mid-May—a dozen of which followed Rob Arnott's fundamental indexing strategy. Daily trading volume decreased 8.3%, to $70.6 billion.

But ETFs' ability to provide investors with a hedge against the market is still attracting flows. Those who believe today's market hasn't yet reached its bottom-as well as those looking to capitalize on recent gains—are using leveraged ETFs more than ever. "People are saying 'I'm happy I'm making money, so now I'm going to pull some sort of hedge against it,' " says Daniel O'Neill, president of Direxion Funds, which has 3x long and short ETFs. "People are skeptical of the market and are also moving to short positions, and finally thinking more tactically."