Monday, August 31, 2015

Polar Opposites

The beginning of last week saw some of the weakest days since the start of the bull market only to be followed by a modest bounce off the lows set during last falls “Taper Tantrum.”  Largely overlooked now, last October’s rally off oversold levels was ignited by dovish comments from Fed President Charles Evans about not raising rates before the economy had been stabilized.  Not surprisingly, we’re living in the Fed’s shadow as the back and forth between the NY Fed and the Vice-Chairman plays out in headlines. Across every data point between now and the next FOMC meeting could be a market turning event, but at ETFG we’re all about finding the bigger trends so we turned to our Quant Screener to study how the last two weeks have shifted the market dynamics.

The hands down biggest winner last week was the energy sector where a nearly 12.5% gain by West Texas Intermediate Crude helped propel energy stocks higher with the broad Energy Sector Select SPDR up 3.59% compared to .91% for the S&P 500.  Domestic energy stocks weren’t the only ones to benefit from the crude recovery as single market ETFs with heavy energy exposure enjoyed a strong week despite a rising dollar with the small SPDR S&P Russia ETF (RBL) seeing a double digit advance along with a 68% increase in its weekly ETFG Behavioral quant score.  Prognosticators were quick to declare this strong advance was nothing more than short covering; after all before last week’s rally crude oil was down nearly 60% and had dropped all the way back to levels not seen since the dark days of 2009 with no recent change in global production to help support the move higher.  Supporting the case for short covering was the weakness in non-energy commodities where both the IQ Global Agribusiness Small Cap ETF (CROP) and the iShares Global Timber & Forestry ETF (WOOD) made our list of funds that saw the biggest percentage drop in the quant scores over the last week.  Last week’s liftoff occurred even with the U.S. dollar making strong headway as comments by monetary policy rock star Stanley Fischer indicated that the Fed was sticking to its “data dependent” policy on future rate hikes.

It was a different story for the utilities and REITs because while energy stocks enjoyed strong performance on the back of rising crude prices, a reversal in sentiment and contradictory statements from the Fed took the wind out of the sails of the defensive favorites.  Both sectors closed down for the week with the two bell weather funds, the Utilities Sector Select SPDR (XLU) and the iShares U.S. Real Estate Fund (IYR), losing 4.2% and 2.8% respectively.  Late July had been especially generous to the utilities as broader equity weakness helped propel the sector to the top of our momentum lists, where it was later joined  by REIT’s as their underperformance last spring (and a stable if uninspiring economy) made their stable dividend yields look all the more attractive.  But both of these classic defensive wagers may have committed the only unforgiveable sin in a bear market; not only did they capture almost all of the broader market’s downside during the rout, the public debate within the Fed over the timing of interest rate hikes hit these two sectors the hardest and subsequently they delivered only a fraction of the markets upside in the latter half of the week and left them deeply in the red overall.  Further complicating the picture is their relatively high valuations and somewhat uninspiring dividends with both XLU and IYR yielding above 3% which while about 100 bps above the ten year Treasury pale in comparison to the 8.25% offered by the largest MLP ETF, the Alerian MLP fund (AMLP.)

And if XLU and XLE trading places was the market equivalent of the magnetic poles beginning to shift, just wait for the week ahead.  One fact about the rally in the second half of last week was that it was on lighter volume than the pullback just days before, a worrisome trend as we move into the week before Labor Day which traditionally has been a period of even lighter volume and when coupled with the first week of the month’s heavy economic release schedule means more volatility is ahead.  After a relatively quiet Monday, manufacturing will take center stage on Tuesday followed by productivity and factory orders on Wednesday before all eyes turn to Friday’s employment report which could be the final factor many traders will consider before the next FOMC meeting in mid-September.  No matter which way the data goes, higher volatility and more rotation is sure to be the order of the day.

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