Investor confidence began to fade rapidly at the start of the third quarter. ETF investors in the U.S. had already reconciled themselves to a slow recovery when the S&P 500 started its roller-coaster ride in early August.

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By the end of trading on Sept. 1, the index was off 4.2% for the year, and industry professionals had all but thrown up their hands on safety plays like the U.S. dollar. The PowerShares DB US Dollar Index Bullish (UUP) was down 6.8%. But that was hardly the worst performer.

The financials sector took a big hit. The Select Sector SPDR Financials (XLF) is off 21.38% year-to-date through Sept. 1. It dropped 9.5% in August alone amid an outpouring of investors' anxiety following a U.S. sovereign credit downgrade and Robert Kelly's resignation from the Bank of New York Mellon. Also, a few weeks ago, the U.S. Federal Housing Finance Agency filed suit against several banks, including Bank of America and JP Morgan Chase, over faulty mortgages.

"There is so much uncertainty in terms of balance sheet health in the financial industry," says Adam Patti, CEO at IndexIQ. "That's really an overhang from the past few years. Every time you think [the worst] is over, something else pops up and concerns come back."

Materials and industrials also dropped by double digits, at 11.56% and 11.53%, respectively, according to Select Sector SPDRs. Both numbers indicate investors are not particularly confident about a strong economic recovery, Patti says. He added that commodity prices were retreating from some of their highs over the last couple of months, so that also dampened the sector's performance.

"The supply-and-demand dynamics are static to where they were a couple of months ago," Patti says. "The stocks just ran up too far, too fast."

There are almost no technical explanations for the subdued performance in industrials. The fundamental outlook is this, experts say: the U.S. needs two consecutive quarters of sustained, substantial growth before investors will feel confident in that sector. "China is really eating our lunch in terms of manufacturing capabilities," Patti says. "They've taken the low end of the market, and a lot of industrial companies are trying to reposition themselves to the higher end of the supply chain."

Fearing a long and sluggish recovery, investors poured money into the SPDR Gold Shares (GLD). On Aug. 22, it had $76.6 billion in assets, and briefly overtook SPDR S&P 500 (SPY), with $74.3 billion, as the world's largest ETF, according to Morningstar. Investors ran gold prices up to $1,882 per ounce by Sept. 2.

It all stems from the U.S. dollar losing its grip on its prestige as the world's reserve currency of choice, said J. Stuart Thomas, principal of Precidian Investments. "Now we seem to be spending out of control like a Third World nation," Thomas says. Despite investors' apprehensions, Patti says gold prices are overblown and buyers will need to trim some of their holdings.

Investors looking overseas for stable growth are putting their confidence in markets overseas. But even some of the largest foreign ETFs stumbled. The iShares MSCI Emerging Markets ETF (EEM) slipped 10.27%. ETFs pegged to German equities, a group seen as Europe's growth engine, also lost some footing after the country's second-quarter GDP was nearly flat at 0.1%, stoking fears of a slowdown. The iShares MSCI Germany Index Fund (EWG) has slid 17.5% year-to-date.

 

Donna Mitchell is a senior editor of Financial Planning.