Monday, October 26, 2015

Familiar Patterns

All eyes remain glued on the equity markets as the S&P 500 did something last week that it hasn’t been able to manage since last October, advancing for four straight weeks as it recovers nearly all the losses incurred during last summer’s bout of free-floating anxiety. Traders and reporters might find themselves developing a case of “highway hypnosis” as each week’s advance follows a familiar and almost mind-numbing formula; minor losses and profit taking at the start of each week followed by a strong push higher on Thursday and Friday as the latest event whether it’s the weekly employment report, speech by a Fed governor or just simple short covering sparks a push higher before the cycle repeats the following week.  But with another FOMC meeting lined-up for this week and the S&P 500 just a hair’s breadth from prior support at 2100, we can’t help but wonder if history might not repeat the same pattern from last October; the market rallied for seven straight weeks with the bulk of the gains came early in the rally before the market stalled out and the S&P 500 became stuck between 2000 and 2100 for nearly a full year while investors waited for some resolution from the Fed.  Sound familiar?

The catalyst for last week’s 2% push that took the S&P 500 back above its 50 week moving average (it hasn’t been stuck below it for more than a few days since 2011) had less to do with anything domestic than the major confidence boosted delivered by foreign central banks.  Thursday’s rally was ignited by Mario Draghi expressing his concerns over the lack stability in EM markets negatively impacting the Euro (making it too strong) and potentially laying the groundwork for an expansion of the ECB’s QE campaign in December as part of a concerted strategy of devaluation.  The markets certainly didn’t misread his intentions as the Currency Shares Euro Trust Fund (FXE) logged a nearly 2.1% loss for the week while hedged equity funds saw their ETFG behavioral scores surge last week with the iShares Currency Hedged MSCI Eurozone ETF (HEZU) seeing it’s score advance by almost 17 points over the week while the fund return 4.4%.  Even that stellar performance wasn’t enough to put the fund on our list of top 100 highest scoring funds where only one hedged European fund makes the list, the Wisdom Tree Europe Hedged Equity Fund (HEDJ) at #81.  Rate cuts by the People’s Bank of China on Friday helped fuel the rally for another day and kept a number of China A-share funds on our list of top performers but what captured our attention was how domestically oriented the list had become.

After last week’s surge by large-cap names like Microsoft and Apple, it’s not surprising that our Behavioral list has a distinctly American feel although the make-up of that list is a potential cause for concern.  Making a rare appearance on our list of top behavioral performers is the SPDR S&P 500 ETF (SPY) at #7 thanks to a 7.5% rally over the last month and while that gain has reinvigorated the bulls, the lack of support from the broader equities is somewhat troubling.  That large-cap earnings continue to beat lowered expectations and could soon be made potentially stronger by a falling dollar has been a familiar theme among investors and just one reason the list of our biggest quant movers for the week include names like the Vanguard Large Cap Index Fund (VV), Vanguard Mega Cap Index Fund (MGC) and Vanguard Industrials Index Fund (VIS) that have benefited the most from that trend.  The powerful rally by the S&P 500 however has pushed SPY back almost into oversold territory based on the 14 day RSI while the % of stocks back above their 50 day moving average is at 76%, a level not seen since February.  Meanwhile small and mid-cap names have picked up only a fraction of the large-cap sectors gains with the iShares Russell 2000 ETF (IWM) and SPDR S&P MIDCAP 400 ETF (MDY) up 2.62% and 3.74% respectively over the last month compared to that 7.5% gain for the S&P 500 we talked about earlier.

Equity rallies typically don’t have very broad beginnings and October’s is no exception with high performing materials and technology stocks on one end with double digit gains over the last month while healthcare stocks are barely treading water with the Health Care Select SPDR Fund (XLV) up a mere .86%, but that could all change on Tuesday when the FOMC holds it’s second-to-last meeting of the year.  Historically investors have written off the October meeting as unlikely to provide any new directions as it’s not followed by a press conference but given the high level of antagonism in public statements between members of the FOMC, the outcome of this meeting will be highly scrutinized. Hawkish members could view the recent drop in jobless claims as further proof we’re inching closer towards full employment and any indication that the FOMC might be close to hiking rates could send the dollar skyrocketing back towards its first quarter highs and help hedged foreign funds continue to outperform.  Retreat from rate hike speculation could help keep domestic stocks on top while igniting more sector dispersion with financials feeling the most pain.  No matter what the outcome, the pattern that has governed equity markets over the last four weeks is likely to be disrupted.

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