Monday, October 12, 2015

Rocking the Boat

The momentum shift in the market last week was profound for those investors who spent the summer preparing their portfolios for the fallout from a tightening Fed.  While the powerful 3.26% surge by the S&P 500 sparked a debate among technicians that it was nothing more than short covering, maybe it wasn’t all that surprising when you consider that the summer rout brought us back to the lows of last October when concerns over the timeline for Fed tightening sent investors running for cover.  Our ETFG Behavioral Report shows new patterns that make sense when many are convinced the Fed’s plans to hike rates are on indefinite hold, but those who think the Fed might yet surprise us might want to study them carefully in case they plan to take the other tack.

Last week we were surprised to find two emerging market funds on our list of top 25 behavioral funds, so try imagining our amazement when we checked the list and discovered that 10 funds with an international focus were now crowding out the top spots that until just recently had been held by biotech funds.  Not surprisingly the top ranked fund is the iShares MSCI Emerging Markets ETF (EEM) which saw a 6.17% gain last week and whose behavioral score has surged by nearly 30% since late September as the possibility of a Fed rate hike began to dim.  While other EM funds appear on the list, the bigger surprise for us was that the weakening dollar has given a shot in the arm to those developed market economies so dependent on supplying commodities to the rest of the globe.  We first talked about the idea of using developed market ETF’s to gain exposure to resurgent commodities and a falling dollar last February (see “Dollar Doldrums) and while several of the funds we discussed including the iShares MSCI Australia Index Fund ETF (EWA) and the iShares MSCI South Africa ETF (EZA) rallied into the early part of spring; a stabilizing dollar and prospects for a Fed tightening led to a significant rout that sent them to scurrying back to support close to multiyear lows.

Even with three voting members of the FOMC saying a rate hike was still on the table last week, the lack of any bad news from China combined with a weakening dollar gave commodities a short in the arm and helped EWA and EZA manage serious gains (7.62% and 5.35% respectively).  That performance might have pushed EWA all the way to #43 on our list, but it was another Commonwealth country that was the true star last week with the iShares MSCI Canada ETF (EWC) surging up the ranks to come in at #9 thanks to a double whammy of strong price momentum and high short-interest despite slightly underperforming EWA with a “meager” 6.72% gain last week.  While the Australian dollar ETF (FXA) experienced a far more substantial surge of over 4% last week compared to a 1.8% gain the for the Loonie fund (FXC), consider the underlying holdings of the two iShares funds.  Both were intended to offer exposure to the broad equity markets of their respective nations and financial stocks make up the largest allocation in both funds, but EWA has a nearly 45% of its portfolio dedicated to that sector compared to EWC’s 31%.  And while EWA might have another 13.5% in materials, remember that Canada is just one big expensive oil well which has been hit hard by falling prices, so the resurgent price of oil has helped EWC’s 22% allocation to energy stocks (along with its 9% allocation to materials.)

Materials were on everyone’s mind last Friday as the start of the earnings season got underway Thursday night with a disappointing report from Aloca (AA) that sent the stock tumbling down 6.8% on Friday and weighed heavily on the SPDR S&P Metals and Mining ETF (XME) and Materials Select Sector SPDR Fund (XLB) although as .07% of the S&P 500, it barely made a dent on the broader equity markets.  But that worrisome start might be just the beginning of a difficult time for equities as the last Friday’s edition of the Factset Earnings Insight Report raises the possibility that earnings for the S&P 500 are likely to be negative for the third quarter (and for the first time since 2009, we could have two consecutive quarters of falling earnings) thanks largely to the energy and materials sectors.  Investors concerned about exposure to stocks with falling earnings should visit the ETFG Equity Grey Market Report as earnings are released to study the potential fallout for different funds and to reorient your portfolio accordingly.  According to Factset, the telecom sector should experience the strongest y-o-y earnings growth and typing Verizon’s ticker (VZ) into the search field brings up a long list of different products for your consideration from the heavily concentrated like the Vanguard Telecommunication Services Index Fund (VOX) to the more diverse WisdomTree High Dividend Fund (DHS).

Don’t let the Fed dictate every move in your portfolio this year.

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