Central Banks Anxiety

With 3 major countries' Central Bank announcements last week, the differences in monetary policy between the U.S. and the rest of the world has only become more pronounced and is now creating anxiety for investors already nervous.  With some of the best performance in 2015 coming from traditional “safe havens” like U.S. Treasuries and Equity Precious metals, we decided it’s time to find out how investors have been reallocating their portfolio’s in January.  Using the ETFG Scanner to rank funds by fund flows over the last month, we found that there are only three broad equity funds in our list of the top 20 and two of those are internationally oriented.

When it comes to Europe, there’s no doubt that easing is finally here and that parity between the Euro and Dollar is only a matter of time.  With the Currency Shares Euro Trust (FXE) back to levels not seen since 2003, investors are taking advantage of currency-hedged funds to play Europe and have fixed their sights on the WisdomTree Europe Hedged Equity Fund (HEDJ) while investors with a broader focus have turned to the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF).  Offering a strict EU investment focus and 100% hedged to the Euro, the performance of HEDJ reflects investor enthusiasm for European equities with a one month return of 6.35% compared to -1.35% for SPY and an positive inflows of over 20% of AUM in that same period.  Offering hedged EAFE rather than strictly European protection, newer and smaller DBEF is up a less earth shattering 1.35% as but has added nearly $741 million to increase AUM to $1.8 billion.

If you were to rank the top 20 funds by AUM growth, the only U.S. oriented broad equity fund making the list is the iShares MSCI USA Minimum Volatility ETF (USMV) which has seen its AUM rise nearly 10% in the last month.  After the first five trading days of the year erased most of the gains from the late December rally and Treasury yields broke below their 2014 downtrend channels, investors sought comfort (and yield) where they felt safest getting it; namely, Utilities, Consumer Staples, and REIT’s, all of which have trailing twelve month yields well above that for the S&P 500.  Over the last month, the SPDR Select Sector Utilities ETF (XLU) only lags behind its consumer discretionary counterpart with inflows of over $785m while the iShares Dow Jones US Real Estate Index Fund (IYR) has pulled in over $488 million.  Investors more concerned about growth than cash flow have either turned their eyes back to healthcare, where another $525 million flowed into the SPDR Select Sector Healthcare (XLV) fund.  Without repeating our concerns over rich valuations for defensive sectors, investors certainly have turned their positioning more defensive in 2015.

Some things are meant to go together, so for those U.S. investors who want European equity exposure, higher yields and aren’t afraid of a little country-specific risk might want to turn their focus to the Deutsche X-trackers MSCI Germany Hedged Equity ETF (DBGR) and the WisdomTree United Kingdom Hedged Equity ETF (DXPS).  With trailing yields of 9.64% and 7.41% respectively, both funds have already proven to be favorites with investors despite the anxiety that most investors may feel when taking on country-specific risk in their international allocations.  DBGR is just one of several German-oriented ETF’s that have seen significant gains in assets in 2015 with performance to match, up 9.54% YTD.

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Clean Energy

Whether sparked by a weak core CPI report or just on oversold conditions, Friday’s broad rally helped take pressure off the energy stocks with the SPDR Select Energy Sector ETF (XLE) making a 3.25% gain on the day.  Despite that strong showing, the top ten ETFG Quant scoring ETFs are all still in the energy sector, but conspicuously absent are the “alternative energy” stocks that dominated in 2013 and early 2014.  While the largest of the clean energy alternatives, Guggenheim Solar (TAN) might only be down 3.87% in 2015 compared to 4.96% for XLE, other larger players in the sector such as PowerShares WilderHill Clean Energy Portfolio (PBW) and the Market Vectors Global Alternative Energy ETF (GEX) are still underperforming (down 7.59% and 5.65% respectively).  Even if energy stocks find their legs soon, could it be lights out for alternative energy?

One factor that may be working against a clean energy comeback is poor momentum as the ETFG technical scores for the most widely traded funds have plummeted to their lowest quartile.  Such relative weakness isn’t all that surprising considering their strong performance in 2013 and early 2014 as momentum darling TAN racked up a 2013 gain of 127.91% while the First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN) made 93.91% compared to 26.25% for XLE and the S&P 500’s TR 35.35%.  That strong momentum carried into early 2014 as both TAN and QCLN strongly outperformed the energy sector and broader market although much of those gains were first eaten up by profit taking before the September correction hit high momentum clean energy stocks hard.  Some alternative energy funds saw losses between September 9^th and the market low on October 15^th of 3x and 4x greater than the S&P 500.  With most alternative energy ETFs still trading significantly above their 2013 lows, it may be some time before investors feel confident that the selling pressure has abated.

If their performance history wasn’t a big enough stumbling block for clean energy ETFs on the road to glory in 2015, their portfolio composition might be.  Like many specialized funds in emerging technologies, alternative energy ETF’s are heavily concentrated with anywhere from 30 to 50 holdings being the norm, giving the funds more volatility and reduced diversification due to cross-holdings.  Large common holdings like SolarCity, First Solar, and SunEdison have weighed heavily on the alternative energy space as lower oil prices dampen analyst expectations for more expensive clean energy solutions.

Other funds including GEX and QCLN had large allocations to Tesla Motors, whose 13% lass in 2015 has heavily weighed down their performance.  And investors may have once praised alternative energy funds for investing in the manufacturers of clean energy technology as opposed to large utility allocations like former darling theme global infrastructure; but that utility orientation may have given them added lift in late 2014 and so far in 2015 as utilities and defensive names continue to dominate. 

But it’s not all cloud and rain in the sector, one clean energy ETF that has managed to avoid the pain inflicted in 2015 is the tiny iShares Global Clean Energy ETF (ICLN), down .41% in 2015.  With 30 holdings, ICLN is heavily concentrated like most clean energy ETFs, but a global focus beyond just solar or wind has given it staying power relative to its peers.  TAN currently has 27 positions with over 65% concentrated in the top 10 and a heavy concentration in underperforming American stocks with 44.45% of its portfolio tied up at home.  By contract, ICLN has approximately 28% of its allocation in U.S. equities which has helped it avoid some of the pain inflicted by SolarCity and First Solar.  Another aspect of ICLN’s global focus is the use of China H-shares while larger TAN has focused buying Chinese solar exposure with ADRs.  That more direct China exposure may have helped weighed down performance in 2013 when ICLN returned 49.1% to TAN’s 127.91%, but may help give it more lift in 2015.

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Sir John, Greece &...

It’s only been a month since our post on year-end sector rotation where we discussed the high short interest in two funds representing two highly dissimilar scenarios, the Global X FTSE Greece 20 ETF (GREK) and Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR.)  Since December 8^th through the close on Friday, ASHR tacked on another 7.47% gain while humble GREK dropped 27.25%.  Given the very different conditions facing these two nations, it reminded us at ETFG of one of Sir John Templeton’s famous quotes: “People are always asking me where the outlook is good, but that’s the wrong question…. The right question is: Where is the outlook the most miserable?”

It was also only a year ago that the markets’ concerns weren’t on whether the EU would survive but whether China might be about to experience its own “Lehman Moment.”  Driven by the need to meet mandated GDP targets through infrastructure investments even as official lending standards were being tightened, off-balance sheet investment trusts had experience phenomenal growth but were looking increasingly insolvent.  Concerns over the state of China’s finances, or the sustainability for high single digit GDP growth were nothing new and the main H-share benchmark, the Hang Seng China Enterprises Index, had been punishing investors for years thanks to its large allocation of Chinese bank stocks.  Between January 1, 2011 and its low on March 20, 2014, the index had declined nearly 27.49% compared to a 48.85% rise for the S&P 500.

It was in that March that Bloomberg noted that the average P/B ratio of the 4 largest mainland banks traded in Hong Kong had dropped to .94, indicating investors had begun to fear the possibility of equity restructuring if not outright nationalization.  Fast forward a year and the situation has changed radically; thanks to a series of confidence inspiring moves including easing reserve requirements and direct capital injections, China’ s largest lenders are again trading at P/B ratio’s above 1 while the Hang Seng China Enterprise Index is up over 31.27% since its low on March 20th.

Switching back to Europe, concerns over the future of the EU project had already led to a punishing six months for the Currency Shares Euro Trust (FXE), now back to 2005 levels while the political situation in Greece seems to only go from bad to worse.  In 2012, it was a challenge from the far-right with Golden Dawn, in 2014 the threat to the status quo is coming from the far-left where the Syriza party led by Alexis Tsipras seems poised for victory on a platform built around the need to write-down existing debts while alleviating the on-going fiscal austerity that has been mandated as part of the ECB/IMF led bailout.  Polls at the start of January showed Syriza with a commanding lead and have sparked reports that Germany is quietly preparing for a Greek exit from the EU.  With that backdrop of more uncertainty after the election and a possible “Grexit”, is it any wonder that the only Greek-related ETF available to U.S. investors, with a 30% allocation to Greece’s largest banks, is now trading at a P/B ratio of .41 according to parent Global X?  Investors are clearly prepared for the worst.

But before investors brace themselves for seemingly apparent collapse of the Eurozone, there are several major events due before the Greek presidential election on January 25^th.  As Gavyn Davies outlined in the January 7th FT, the next few weeks could be critical to the success of failure of the great EU project beginning with a potential opinion from the European Court of Justice on Germany’s challenge to the ECB’s Outright Monetary Transaction program, begun in 2012 as part of his “whatever it takes” campaign that has yet to be used.  Davies notes that, spoiler alert, the Court of Justice has shown an inclination towards favoring programs that reinforce European integration, but even then Germany will only take their opinion under advisement.  Next is a potential QE announcement from the ECB on January 22nd as low inflation becoming deflation seems to be giving the ECB the cover necessary to start a QE-like program.  Greek voters will be watching both of those developments closely before their election and volatility is sure to remain high heading into the election, where the lead held by Syriza narrowed slightly in recent polls.

While the challenges facing Greece are far different from those that beset Chinese investors, it would be hard to find a situation that better fits Sir John’s maxim to invest where uncertainty and doubt rule the day.  However, the question remains to be answered whether investors will be rewarded for enduring another Greek drama.

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Golden Fetters

After four difficult years, investors can be forgiven for skipping over the precious metals sector, but a recent confluence of events has us at ETFG wondering if the new era of “golden fetters” might be coming to an end?

In 2014, Gold investors watched the Market Vectors Gold Miners fund drop another 12.44% to take its three year annualized return to a negative 28.41% and watch two major rallies in the first half of the year push GDX up nearly 30% only to see the fund collapse over 36% from August 13^th to November 5^th as collapsing inflation expectations joined with broad equity weakness.

At first glance, there may not seem to be much room for optimism for GDX in 2015 following a 19.26% loss in the third quarter, GDX saw an asset outflow of nearly 13% in the fourth quarter bringing total assets down to $5.6 billion, a far fall from the over $9 billion the fund managed in 2011 and 2012.  However, there is a significant, recent improvement in GDX’s Quant Behavioral Score from a low reading of 40.6 on November 24^th to a current reading of 54.32.  A substantial portion of this rise has been the improvement in momentum.  Our more technically oriented readers will note that GDX broke out of its downtrend channel in the second half of November and has since retested its previous lows only to finally close above the fifty day simple moving average of improving volume last Friday.  While this improving technical strength might still be met by a wave of further selling, the short interest remains high and any further strength could lead to further advances.

For those readers who need more to build a case on than Technical Analysis, the plummeting five year TIPS breakeven would hardly seem to support an advance in gold prices.  According to the St. Louis Federal Reserve, that five year breakeven rate hit its high reading for 2014 in late June at 2.03% and since then has continued to advance in a different direction, falling to the 1.17% - 1.3% range not seen since late 2011.  Despite the tenuous relationship between the actual changes in inflation and the price of gold, there does appear to be a relationship between changes in inflation expectations and gold, with the price of metal closely tracking the rising 5 year TIPS breakeven until mid-2011 when gold fever overtook fundamentals.  The relationship between the two reasserted itself in 2012 and in it was only in early 2013 that the price of gold finally fell out of the range between $1,500-$1,800 as the 5 year breakeven rate went from 2.3% to 1.65% in December 2013.  With the fall in the price of crude oil seemingly arrested for the time being and inflation expectations back to their post-2009 lows, gold (and the gold miners) could be poised to move higher in the event that expectations begin to revert back to their recent mean.

The final argument for a bullish gold outlook might come from the East as the PBOC begins to loosen monetary policy in an attempt to jump start their economy after growth rates hit lows not seen since the early 90’s.  The first cut in rates in over two years by the PBoC on November 21^st capped a tremendous shift in Chinese monetary policy that has been seen by some to be the primary driver for the Shanghai Stock Exchange finally finding support before rising to close out 2014 52.87% higher than it started the year.  In what could be a clear case of “buy the rumor, sell the fact,” gold miners began gaining strength in early November as whispers that the PBoC, so far unsuccessful in stimulating growth by targeted cuts to the loan reserve ratio’s and liquidity injections, would have to take bolder measures to help the economy grow and ease overcapacity issues.  The rate cute and $65 billion of new liquidity injected into the banking system in December could help stimulate lending and further aid the rise in consumer spending.  With growth expected to slow further in 2015, investors could become confident about more easing in the future which could provide even further lift to Chinese equities and to gold.

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2015 New Year's Message

From all of us here at ETF Global, we hope that you and your families are enjoying a wonderful holiday season and Happy New Year!

We would like to express our sincere appreciation with a heartfelt thank you to all of our subscribers, clients and supporters for helping to make 2014 a banner year for our firm.  Our goals for 2015, while lofty, are centered on delivering an even more robust research, data and product platform for our users and as always will be guided by your feedback and input - we look forward to fulfilling on these aspirations in this new year.

We wish you and your families great health, happiness and prosperity for 2015 and thank you for reading ETFG Perspectives!