Softer Rate Hike Cycle Ahead?

The “Good Friday” Jobs Report may be one of the most anticlimactic in memory as the sharp slowdown in the jobs growth rate ran smack into a market closed for the holiday weekend and while it truly was a good Friday for anyone still long the PowerShares DB US Dollar Index Bullish Fund (UUP), what sort of situation will investors face at this morning’s opening?

The lack of trading on Friday meant that reporters had more time than usual to debate how a weakening economy might impact the Fed’s plans to raise rates and giving investors of all stripes time to debate how to position themselves.  But at ETF Global, it provided us a chance to peruse our ETFG Quant movers report to learn how investors have already been positioning themselves for a potentially softer rate hike cycle.

Starting with the weekly changes in the ETFG Behavioral Quant Movers Report, 8 of the 10 biggest % gainers for the week have some degree of negative correlation to changes in the dollar that could help propel them higher in the event that dollar sell-off continues into next week.  The biggest percentage gainer was the FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (TLTE) whose Behavioral Quant score rose by over 106% as the fund continues to outperform vastly larger rival iShares MSCI Emerging Markets Index ETF (EEM) by over 150 bps year-to-date.  With over 2000 holdings, investors might be more than a little curious how this fund differs from average EM ETF and for that, you need to lift the hood a little.  Compared to the average EM fund, TLTE is weighted towards smaller cap stocks with over 15% in small cap positions compared to a meager .47% for EEM and giving the fund an average market cap of $8.5 billion compared to $20 billion for EEM.  A tilt towards small caps isn’t the only defining feature of the fund as the portfolio is also skewed towards value stocks that have seen weaker earnings growth than those found in EEM leaving investors with a portfolio heavily exposed to those stocks that could potentially see strong price appreciation as the dollar liftoff continues to falter.

TLTE isn’t the only fund with small cap EM exposure to see a strong pick-up in momentum last week as the EGShares Beyond BRICs ETF (BBRC) and the WisdomTree Emerging Markets Small Cap Dividend ETF (DGS) both saw their behavioral quant scores rise by more than 50% last week.  Like TLTE, both funds are intentionally bent towards a focus on smaller companies than are found in EEM although investors should consider BBRC a more “conservative option” as it has an overall higher average market cap ($13.7 billion) than TLTE.  BBRC also eschews a focus on value stocks, favoring a more balanced approach built around gaining exposure to a more diverse range of nations than are currently found in EEM.  BBRC has no exposure to more developed Asian markets like China, Taiwan or South Korea instead focusing on markets like Indonesia, Malaysia and Qatar that were up 2%, 2.45% and 5.2% respectively last week.  Prospective investors also need to come prepared with an opinion on the South African Rand as one of last year’s biggest losers against the dollar makes up the single largest currency exposure of the fund.  Investors looking for a more “aggressive” fund like TLTE have found DGS more to their liking as the fund concentrates almost exclusively on small and micro-cap names leaving the fund with an average market cap of a mere $1.3 billion compared to $8.5 billion for TLTE although it carries a much higher ETFG volatility ranking as a result.

So if an emerging market flavor permeates some our biggest behavioral winners for last week was there anything that defined the biggest losers?  So far the only clear trend has been one that might be best called “the first shall be last” as the healthcare rally that began in late February continues to run on fumes with two healthcare funds among the biggest losers last week.  Leading the advance in the opposite direction were the PowerShares Dynamic Pharmaceuticals Portfolio (PJP) and the Market Vectors Biotech ETF (BBH) where the serious loss of momentum has left many wondering whether the end has come.  The Healthcare Select SPDR (XLV) has underperformed but the worst of the pain has been saved for biotech sector with the iShares NASDAQ Biotechnology Index (IBB) down an astounding 7.32% in the last two weeks compared to a negative 3.89% for XLV and a 1.95% loss for the S&P 500.  PJP and BBH merit special mention for their heavily concentrated portfolios with both funds holding a mere 26 positions compared to 149 holdings for IBB while PJP’s use of ‘Pharmaceuticals’ in its name can’t obscure the fact that its allocation to biotechnology is larger than BBH’s.  With one of the biggest leaders of the bull market losing steam while long despised emerging market stocks continue to gain favor, this might be the last “good Friday” for investors with a U.S. only focus for some time to come.

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