Monday, June 22, 2015

Rising Risk Aversion

While Thursday’s weak CPI report gave hope that inflation might stay too low for the Fed to realistically raise rates, much of the week’s equity rally had more to do with four weeks of steadily receding momentum than with the hope that rate hikes might be postponed into 2016 - even the more dovish Fed couldn’t stand in the way of what was either profit-taking or portfolio de-risking.

Domestic investors continue to debate the Fed and global investors have been focusing their attention on the developments in one of the world’s smallest and one of the largest markets; Greece and China making it easier to show the increasing aversion to risk that seems to be taking hold of the market.

It should come as no surprise to our readers that we’re starting our global review in China where the A-share market saw its single largest weekly drop since 2008 with the Shanghai Exchange dropping nearly 13.3% for the week with Friday gap opening down before shedding 6.4% on the day.  Chinese equities have been a regular topic of ours, most recently on March 16th where we pondered whether the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) was due to cool off after the fund saw a clear loss of momentum in the first quarter after 2014’s blistering 53% advance.  Instead we learned a valuable lesson in top calling as ASHR rocketed up another 50% from March 16th to June 12th as investor demand for higher rates of return met with increasing liquidity provided by the PBoC via another rate cut in May.  ASHR has been through more than its fair share of profit taking cycles in the last year with the fund going from overbought to nearly oversold in a little as a week, but while it’s been said many times before, this time it might be different.  Not just because the PBoC has made the massive increase in investor margin a point of concern or the recent that Morgan Stanley study that showed most investors feel the market is a bubble but because those investors are actually doing something about it.  Even as investor short-interest remains high, there has been a clear loss of momentum for China A-share funds as ASHR has seen over $300 million in assets leave the fund in the last two weeks, a nearly 19% drop!

But while investors are warming up to reality in China, a somewhat different situation reigns in Europe as the flood of capital from brave and intrepid investors who have put capital to work in European stocks despite the slow motion disaster in Greece has slowed to a trickle. Hundreds of articles have been written about the amount of capital that has found its way to funds like the WisdomTree Europe Hedged Equity Fund (HEDJ) which pulled in $13.5 billion in the first five months of the year or the Deutsche X-trackers MSCI EAFE Hedged Equity (DBEF) with a more modest $9.9 billion take, but few have been published talking about the dramatic slowdown in new flows with only $144 and $464 million heading into the two funds respectively over the last two weeks.  And while it’s reasonable to assume that thanks to the dollar’s weakness the capital has been heading to unhedged or country-specific positions, that certainly isn’t the case with the iShares MSCI EMU Index (EZU) pulling in less than a half of a percent in assets in the last two weeks.  Even tiny GREK’s $11 million take in the last two weeks (some of which is for shorting) is a fraction of the $218 million the fund has seen flowing in since the start of the year.  Investors are clearly moving into a wait-and-see mode while they await the latest arguments from the Troika.

Closer to home, if there’s one segment of the market where prognosticators feel a return to reality is most needed it’s the biotech sector where a 5.19% gain for the week by the SPDR S&P Biotech ETF (XBI) took the 2015 return to 35.78% and helped keep the fund in the top 5 behavioral scoring funds.  The catalyst for the nay-sayers is the recent IPO of Axovant Sciences (AXON) who’s priced popped 99% at its debut on June 11th, giving the small company an initial valuation of $2 billion dollars, although the stock has since dropped over 35% helping shed nearly $600 million from the market cap.  And while the market is right to be concerned over the fury of interest for a small-company that’s only been in existence for nine months without a revenue generating product (it’s going to Phase III trials), what has us interested is that despite the sky-high valuations, investor enthusiasm for the sector seems to be boundless.  XBI is currently leader of the biotech pack based on our ETFG behavioral factors and while the fund only has a quarter of the assets of the iShares NASDAQ Biotechnology ETF (IBB), the fund’s focus on small biotech stocks has kept its short interest near record highs even as IBB’s continues to fade.  One factor keeping it high is that XBI’s average market cap is slight more than $2 billion compared to $20 billion for IBB as investors continue to short shares in the hope that reality sinks in sooner rather than later.

Thank you for reading ETF Global Perspectives!

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