Monday, March 23, 2015

Green Flags Ahead?

What a week to be in the market as the FOMC’s press release on Wednesday caught investors by surprise.  While the Fed may finally be out of patience with its zero interest rate policy, the significant downgrade in FOMC expectations for economic output and anticipated interest rates was like waving the green flag at the Indy 500, EVERYTHING not tied to volatility or the U.S dollar took off like a rocket.  But despite the return of the “risk-on” mode, the S&P 500 was unable to break the highs set last month as investor enthusiasm continued to shift overseas.  With the PowerShares DB US Dollar Bullish Index (UUP) having its worst week since the start of its 2014 rally, could the dollar be in for more pain ahead and what can our ETFG Quant scores and fund flows tell us about the early winners?

The dollar’s loss has been the Euro’s gain and one of the most powerful movers last week were international equity funds where unhedged products racked up solid gains displacing the hedged funds that had previously dominated the ETFG Behavioral 25.  One of the strongest quant scorers in 2015 has been the Wisdom Tree Europe Hedged Equity (HEDJ) whose asset base has grown to $12.6 billion thanks to over $10 billion in flows over just the last three months making it the largest of the hedged European products.  But HEDJ’s quant score has continued to fall and with the largest unhedged European equity fund, Vanguard European Vipers (VGK) up 4.6% last week compared to .39% for HEDJ, it wasn’t surprising to us to see the Behavioral list now increasingly dominated by country specific European funds.  Making the top 25 are the iShares MSCI Ireland Capped ETF (EIRL) at #18 and the iShares MSCI Spain Capped ETF (EWP) at #23 (VGK is only #45.)  While both nations outperformed the S&P 500 last week, Ireland’s improving credit rating and strong GDP growth in 2014 have made it the darling of the year outperforming both the VGK and iShares MSCI Germany (EWG) although the fund lagged VGK last week (up 2.52%).  Spain’s political troubles with new Leftist party, Podemos, on the rise left investors concerned about whether the Eurozone’s 4th largest economy could be facing its own exit from the EU and shattering the Union in the process.

And what about international equities in those “commodity” economies we talked about on February 23rd?  The iShares MSCI Australia Index fund (EWA) still on the list at #14 while iShares MSCI Canada Index fund (EWC) holds down the #8 spot.  While both funds have seen their behavioral quant scores gyrate in a relatively tight range over the last month following the 20% selloffs both EWA and EWC had in late 2014, the shifting expectations at the FOMC have allowed both funds to reclaim lost ground.  Both funds have their largest single sector weighting in financials, energy-rich EWC has continued to lag EWA with the fund down .94% (including last week’s 3.35% gain) since our last posting compared to a 1.74% (up 5.6% last week) gain for its Australian counterpart.  Those investors looking to get in on the gains for the unhedged international funds might want to consider how much of the return from relatively stable developed markets might have already been realized over the last few weeks.  Australia and Canada have made up a lot of ground in the last three days after their currencies depreciated against the dollar by 7% and 10% respectively in 2015 (and a lot more in 2014).  The biggest loser in 2015 remains the Brazilian Real, down 21.53% and even its slight appreciation last week was enough to send EWZ up 7.61%.

International equities weren’t the only ones being pushed higher by the declining dollar last week as the inflation and interest rate sensitive precious metals sector achieved lift-off.  The first quarter started off with a bang for the sector as investor anxiety over a weakening S&P 500 and other global mayhem helped overcome a rising U.S. dollar with SPDR Gold Trust (GLD) up 9.35% in the three weeks ending January 20th, not to mention the iShares Silver Trust up 14% and the long-suffering Market Vectors Gold Miners (GDX) up a whopping 24.86%.  But the possibility of a rising rate environment (and higher opportunity costs) once again crushed golden dreams and heading into last Wednesday the sector was trading in the red for the year with massive asset outflows.  As everyone continued to go long the dollar UUP gapped open higher to close at 26.40 on Wednesday the 11th, the five days outflows from GLD, SLV and GDX topped -1.82 billion, -1.16 billion and -256.34 million respectively.  While it’s too early to write off the dollar rally even with the end of the Fed’s patience, the shift in the dot plot breathed new life into the sector; GLD and GDX have managed to attract assets over the last week to the tune of $302 million and $219 million while SLV has narrowed its outflow to $70 million.

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