Energy and Healthcare

For the first time in a LONG time, energy stocks were not the biggest losers last week and while most of the lower volatility sectors outperformed, healthcare stocks continued to lose momentum.

One of 2014’s biggest winners, healthcare stocks, continued to sell-off on a combination of year-end profit taking and negative announcements affecting Gilead Science (GILD.)  Making up over 6.5% of the Healthcare Select Sector SPDR (XLV) and 15.25% of the Market Vectors Biotech ETF (BBH), the recent deal between AbbeVie and Express Scripts put the hurt on the healthcare sector and has led to a war of words online about whether healthcare stocks can continue to outperform in 2015.

While we wait to see if healthcare stocks underperform the broader market for the third time in three weeks (something they haven’t done since mid-2013), one area where healthcare names continue to dominate is in valuations.  The recent sell-off has helped take down some of the premium valuations but with the broad XLV is currently trading at a trailing P/E multiple of 21.32 and BBH at 29.77 versus SPY at 17.6.  It wouldn’t be a stretch to say that healthcare values are…well stretched and both ETFs are trading in the upper half of their historic P/E multiple trading range.  These high multiples have also helped push down our ETFG Green Diamond Reward rankings for the broader healthcare ETFs to below that for the S&P 500, although Gilead Science again might be to blame for much of that.  According to the December 19^th edition of Factset Earnings Insight, Gilead was expected to be the single biggest contributor to healthcare sectors double digit earnings growth rate.  In fact, if Gilead was excluded, the growth rate would fall from 16.8% to 8.3%!  If Gilead does see weaker earnings growth going forward, the broader sector could feel the pain for some time to come.

What about those investors who are looking for lower volatility and the heartache that often comes with biotech investments; is there no where for them to turn to in the healthcare sector?  While biotechnology names may have seen the worst of the sell-off, another one of this year’s higher fliers, pharmaceuticals, haven’t been spared either with the iShares DJ U.S. Pharmaceuticals ETF (IHE) up nearly .2% over the last month while the S&P 500 has been up over 1%.  While sporting an ETFG Risk Rating nearly twice that of XLV, IHE also continues to trade at the highest earnings multiples in its history, seemingly offering an unattractive mix of risk and reward.  The same can be said for the SPDR S&P Health Care Services ETF (XHS) and the SPDR S&P Health Care Equipment ETF (XHE) who also trade at close to historic multiples resulting in Red Diamond Risk ratings that are higher than their Green Diamond Reward scores.

At the end of the day, investors might be better off seeking to diversify their portfolio away from further healthcare exposure in 2015, but that might be easier said than done.  After four solid years of outperformance, healthcare stocks now make up 14.8% of the benchmark and trail behind the #2 sector, Financials, by around a tenth of a percent while energy stocks have dropped to 8.39% of the S&P 500.  That large weighting within the benchmark might be why we saw the largest fundamental score drops (potentially indicating strong buying) occurring either in low volatility domestic sectors or in international equity such as the Deutsche X-trackers MSCI Europe Hedged Equity ETF (DBEU).  Could the early asset allocators be preparing themselves for a more lackluster year in 2015?

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Fed Patience makes for Happy Holidays

Just when investors were starting to wonder if there would only be coal in their stockings this Christmas, Santa Yellen helped deliver some much needed cheer with her announcement on Wednesday that the Federal Reserve will be “patient” when it comes to raising rates in 2015 or 2016 or whenever.  Coupled with a slight drop in inflation expectations, equities were off to the races in the second half of the week and offering underperforming large cap managers everywhere a reason to buy with both hands before the Santa Rally leaves them behind.  And with risk back on the menu last week, it was understandable that the low volatility sectors we discussed here last week such as Financials Select Sector SPDR Fund (XLF) and Vanguard Information Technology Sector ETF (VGT) both lagged the broader S&P 500’s 3.4% move for the week.

Perhaps the least surprising move was the strong advance made by the Energy Select Sector SPDR Fund (XLE), up 9.53% for the week including a jaw dropping 3.2% advance on Friday as the major energy benchmarks managed strong advances on “Quadwitching” day.  While select energy names have appeared near the top of our screener results for some time now, with both Brent and West Texas down around 50% since June as concerns on overproduction and slowing global demand, energy investors have found themselves pushed into a previously undiscovered level of misery.  It might be natural to see energy stocks recoupling with broader equities after Wednesday’s FOMC announcement but prior to this week’s rally, previous attempts to buy into XLE with the assumption that a rebound or even dead cat bounce was way overdue were met with more selling and big gap downs, so we have to ask whether this rally that began on Tuesday is more than simple short covering?

First. we looked at the fund names that made the biggest gains last week and while the broad XLE’s performance was impressive, it paled in comparison to the gains in the oil services and equipment sector with SPDR S&P Oil & Gas Equipment & Services ETF (XES) up 14.35% for the week while the larger Market Vectors Oil Services ETF (OIH) was up over 11%.  The strong performance came from the start of merger mania as Talisman Energy announced on Tuesday it was to be bought out by Repsol for $8.3 billion.  While not included in most energy ETFs, the stock had been trending higher since 12/11 and helped spark a rally in other names that could become potential takeover targets such as Nabor Industries, up 36.3% last week and Denbury Resources (also up 30%), both of which have seen their daily volume more than double compared to their three month averages.

So besides playing for position in advance of a potential merger, is there anything else that could offer more lift to the energy sector?  Energy names were well represented on our list of biggest ETFG Quant Behavorial score changes as improving short-term price momentum combined with still high short interest with the First Trust Energy AlphaDex Fund (FXN) seeing its behavioral score climb nearly 80% last week!  And despite the strong week, energy stocks still offer among the best relative values in the market with trading at a P/E multiple of 12.33 compared to 14.63 for XLE and 17.60 for the broader SPDR S&P 500 ETF (SPY).

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Low Vol

They say imitation is the sincerest form of flattery, so appreciated John Auther's piece last Wednesday “Low Vol Stocks on a Winning Streak” over at FT.com.  While Mr. Authers may share our own concerns that investors have pushed the prices for low-vol stocks to their highest price-to-earnings multiples in years with many trading at a premium to the market, investor enthusiasm has only slightly slackened in the month since our last posting on the topic. The largest domestic low-vol ETF, the Powershares S&P 500 Low Volatility (SPLV), has taken in another $379 million in new assets while the winner of the least risky ETF as ranked by our ETFG Red Diamond Risk system, iShares MSCI USA Minimum Volatility Index (USMV), pulled in nearly $200 million.  But while growing your assets by 5% - 10% is nothing to sneeze at, investors may be shifting their focus to the individual components of the funds.

While SPLV and USMV may have below average ETFG Red Diamond Risk Ratings, they also have low Green Diamond Reward scores as both have nearly 30% of their assets in Utilities or Health Care stocks trading at peak valuations. But both SPLV and USMV also share large allocations to Financials (23.5% and 11.7% respectively) and recent fund flows show large amounts moving to that sector. The biggest winner over the last month has been the iShares U.S. Financials ETF (IYF) where a nearly $700 million dollar inflow has almost doubled AUM of the fund while the larger SPDR Financial Select Sector Fund (XLF) has seen a nearly 10% increase in AUM with an inflow of 1.67 billion. Besides a smaller allocation to Berkshire Hathaway, IYF has a 5% allocation to Visa and Mastercard which aren’t part of the XLF benchmark although both are included in USMV.

Besides offering lower volatility and deviation than SPY, what else could XLF or IYF bring to the table?  Investors may be setting their eyes on how to take advantage of the first anticipated increases in the Fed Funds rate in 2015.  The financial sector has been picking up steam relative to the broader market ever since the beginning of December when Stanley Fischer first began discussing the necessity of changing the language in FOMC communications regarding interest rate increases with XLF now up .33% over the trailing month while SPY is down 1.64%.  Depending on the outcome of this Wednesday’s FOMC announcement, financials might finally be able to take-over a leadership spot in the sector rankings heading into 2015.  Investors interested in adding financial performance but with even less volatility might consider the more specific PowerShares KBW Property & Casualty Insurance Portfolio (KBWP) which currently sports a Red Diamond Risk Rating of 2.7 and offers exposure to a sector that constitutes 7.7% of USMV and 12.2% of SPLV.

For those readers who used to hold AIG or Lehman in their portfolio’s, IYF’s focus on stocks like Visa and Mastercard leads us to another sector to keep on your radar, tech stocks, which make up 13.3% of USMV.  Both the Technology Select Sector SPDR Fund (XLK) and Vanguard Information Technology Index Fund (VGT) have been gathering assets over the last month while offering less downside than SPY.  VGT has been the standout, down -.35% over the last month versus -1.54% for SPY and VGT also saw its behavioral score jump 34.38% last week, taking it to #21 on our list of top 50 ETF’s.  The devil is in the details as to why VGT has become the standout sector star; XLK has a 4.8% allocation to Verizon and 4.2% in AT&T, offering more exposure to one of this year’s worst performing sectors, telecoms.

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Year End Sector Rotation

With three weeks left in December, it’s time to get serious about one of the major events for asset allocators and that is the annual sector rotation.  2013’s powerhouse sectors like Industrials and Consumer Discretionary broke down at the starting gate and racked up early losses for the year while 2013’s underperformers like Utilities and REIT’s are up nearly twice the S&P 500’s take in 2014.  While for some investors this process is as simple as looking at a Callan table and investing in whoever ranks last, let’s check in on our list of the top behavioral movers to see if we can glean any early indications for what 2015 might have in store for us.

After the strong performance by international markets over the last month, it’s surprising not to have more foreign ETFs on our list.  While James Bullard’s remarks on October 16^th about delaying the end of QE in the states may have jump started an international equity rally, Mario Draghi has been adding fuel to the fire with his own commitment to expanding the ECB balance sheet with an asset purchase program potentially in the offing early next year.

Over the trailing month ending 12/5, the SPDR S&P 500 (SPY) has gained 2.8% while the iShares MSCI EMU Index (EZU) has shot past it with a 4.92% gain led by this time by Germany and the Netherlands while more politically unstable France and Italy trail.  With Chairman Draghi’s commitment to taking the Euro behind the woodshed as it falls to levels not seen since 2010, the real winners over the last month were currency hedged ETF’s such as the Wisdom Tree Germany Hedged Equity Fund (DXGE) up over 7.94% and the Deutsche X-trackers MSCI United Kingdom Hedged Equity ETF (DBUK) up 5.38% who made our list at #2 and #22 respectively.

Perhaps the two most surprising funds on the list are the Global X FTSE Greece 20 ETF (GREK) and Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR).  Last Friday’s anticlimactic .86% drop for ASHR capped an incredible weekly gain of 13.83% as the parabolic rally that began in late October on the promise of easier monetary policy restarted the summer rally in Chinese a-shares.  If ranked purely on momentum, ASHR wouldn’t make the list of the top 355 funds (neither would GREK); what really pushes them to the top slots are implied volatility and high short interest.  After such a powerful rally with what John Murphy might describe as a “bump and run formation” it seems a sound strategy to short ASHR at these levels, but with such a large short-interest it’s a matter for debate who’ll be laughing last.  GREK is a slightly different story; with a YTD return of -22.5%, GREK would be close to dead-last among emerging market nations but situated within the Eurozone Monetary Union, Greece might offer a cheaper and higher yielding route to investing in those nations that have the most to gain from a program to expand the ECB balance sheet.

With domestic equity returns being largely driven by growth in earnings rather than in multiples, it’s reasonable to find a number of growth ETFs making the list including the Vanguard Growth ETF (VUG) or those sectors with high cash flows to support future growth such as the Technology Select Sector SPDR Fund (XLK).  What surprised us was the serious drop in healthcare related ETFs on this list.  With nearly twice the 2014 return of SPY, XLV is nowhere to be found in our top 25 while a list that was once dominated by biotech names name only counts 1 among its members with the Market Vectors Biotech ETF (BBH) currently at 25.  Recent momentum has been strong with the sector (using XLV as our benchmark) likely to outperform SPY for the fourth year in a row but that strong performance could be frightening away investors already cautious about the length of this bull market.  Recent drops in short interest and the put/call ratio have pushed down the behavioral score for many healthcare names.

Who has taken their place?  Despite (or perhaps because of) the US dollar’s tremendous performance this year, materials and commodity names have been climbing the rankings.  Whether this is due to expectations for a pullback in the dollar or stronger commodity demand from a resurgent U.S. or China, it’s too soon to say.  And as mid-caps have begun to catch-up to their large and mega cap brethren, the presence of PowerShares Fundamental Pure Mid Growth Portfolio (PXMG) shouldn’t come as a shock to anyone.  But no matter what, 2015 will bring a very different market than the one we’ve enjoyed in this last year.

Thank you for reading ETFG Perspectives!

Weekly Equity Select List - 12.1.14

The ETFG Select List  each week features the 5 most highly-rated equity ETFs by Sector, Geographic Region and Strategy as ranked by the ETFG Quant model.  For this coming week, below please find those groups and the Top 5 ETFs that comprise the highest group average by Sector, Geography and Strategy – you can access the entire list for this week here:  ETFG Weekly Select List - December 1, 2014

1. SECTOR:  This week’s top rated group by average ETFG Quant score is the Energy sector.

Sector:  Energy                                 Group Average:  69.88
Rank	Ticker	Focus	Region	TER	Risk	Reward	Quant
1	OIH	Energy	Global	0.35%	5.75	10.00	75.90
2	PSCE	Energy	North America	0.29%	5.54	8.41	69.10
3	XES	Energy	North America	0.35%	5.93	8.28	68.90
4	XOP	Energy	North America	0.35%	5.63	7.63	67.80
5	XLE	Energy	North America	0.16%	4.35	7.87	67.70

2.  GEOGRAPHY: The Geographic top rated group remains the North America Region.

Geography:  North America             Group Average:  68.12
Rank	Ticker	Region	Focus	TER	Risk	Reward	Quant
1	PSCE	North America	Energy	0.29%	5.54	8.41	69.10
2	XES	North America	Energy	0.35%	5.93	8.28	68.90
3	XOP	North America	Energy	0.35%	5.63	7.63	67.80
4	XLE	North America	Energy	0.16%	4.35	7.87	67.70
5	IEZ	North America	Energy	0.45%	5.33	8.18	67.10

3.  STRATEGY:  The Strategy top rated group transitioned this week Broad Equity.

Strategy:  Broad Equity                        Group Average:  64.12
Rank	Ticker	Focus	Region	TER	Risk	Reward	Quant
1	DXJ	Broad Equity	Asia-Pacific	0.48%	3.16	8.17	66.10
2	EWY	Broad Equity	Asia-Pacific	0.62%	3.97	7.78	64.80
3	DXJS	Broad Equity	Asia-Pacific	0.58%	4.48	7.78	64.50
4	PGJ	Broad Equity	Asia-Pacific	0.70%	5.26	8.84	64.20
5	AXJL	Broad Equity	Asia-Pacific	0.48%	4.76	8.35	63.70

This ETFG Select List is meant to be a quick reference guide and not to replace checking the daily ETFG Quant Rankings, Green Diamond Reward Ratings and Red Diamond Risk Ratings.  To best support the ETF selection process, ETF Global strongly encourages users to perform a more comprehensive review by utilizing the ETFG Scanner and additional tools and resources available at www.etfg.com to further research and diligence exchange-traded-funds.

Thank you for reading ETFG Perspectives!