Divergences in Play

While the bulls had reason to celebrate last week as the S&P 500 surged 3.27% and nearly recaptured all of the prior week’s losses, they were denied a final victory over the bears thanks to lighter volume and a muddled close on Friday as the lack of any economic releases left investors with no data points to trade.  For the second week in a row, our biggest quant score changes lacked any clear pattern or sign of a new trend to use as a weather gauge for the markets.  Instead of calling it a week and focusing on turkey and football, we’ve decided to go back to our list of top behavioral scoring funds to study the divergences, or what’s not on the list, to determine what holes might be lurking in investor portfolios.

Maybe the biggest disconnect on our list of top scoring behavioral funds is the lack of international funds that don’t have “China” somewhere in their name despite the possibility of the biggest divergence between global central bank policies in decades.  The U.S. dollar has been one of the more consistent winners over the last month thanks to the increasing sense of certainty that the Fed will initiate its first rate hike in December.  That has helped push the PowerShares DB US Dollar Index Buliish ETF (UUP) up another .7% last Friday and close to last spring’s highs.  With the ECB and PBoC locked in perpetual easing mode, it would seem like going long the dollar is a slam dunk but only one hedged currency fund made our behavioral quant movers list and its score was going in the wrong direction.  Even though the dollar has been pushing higher and unhedged international equity funds have felt the corresponding sting lately, there’s been no corresponding increase in behavioral scores for hedged international funds.  From their relatively low scores, you’d have a hard time recognizing the WisdomTree Europe Hedged Equity (HEDJ) and Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) as the two biggest asset gather’s in 2015.  That success is probably what helped HEDJ make the 100 thanks to a strong short interest ratio while DBEF continues to have positive price momentum but little else going for it that would help push the fund into the top 300 funds.

The path for future rate hikes is likely to be shallow as the Fed has yet to achieve the two percent inflation target it set for itself several years ago.  While the U.S. economy has been strong enough to endure a minor rate hike, the weak global outlook has many turning to the “one-and-done” policy outlook where the Fed raises rates only once or follows a very gradual and shallow rate hike path.  That belief (or lack thereof) may explain why UUP has pushed close, but not all the way back to, its former highs and on declining volume, potentially signaling that a further push higher for the dollar is problematic at best.  The end result is emerging market and natural resource heavy nations that suffered the worst capital outflows have been among the strongest performers.  Consider that while the Deutsche X-trackers MSCI Brazil Hedged Equity ETF (DBBR) managed a strong 2.5% gain last week, the unhedged iShares MSCI Brazil Capped ETF (EWZ) delivered a stunning 9.6% gain that kept it at the #23 spot as the dollar lost over 3.5% to the Real last week.

While some traders are looking forward, a lot more are looking behind them.  Even though a number of other Latin America and natural resource funds make the top 100, the list still has a decidedly American (and also Chinese) feel to it as domestic investors decide to go with what they know heading into a traditional low volume time of year.  In fact, “going with what they know” might be the perfect name for the list of top scoring funds given that they reflect some of 2015’s biggest winners although the Market Vectors Retail ETF (RTH) that we recently discussed failed to crack the top 100 despite a strong 4.9% advance although the consumer discretionary sector is well represented with three funds in the top 25.  Then again, so is the biotech sector with three funds not to mention an assortment of funds devoted to pharmaceuticals, technology stocks, bank stocks and of course, China.  The only consistency among the top 25 is that each fund represents a sector or theme that at some point dominated the headlines in 2015 but there time at the top might be coming to an end as those emerging market and natural resource funds we talked about in our post “Leaning into the Wind” last July that made up the bottom of the behavioral list have seen their scores steadily improving leaving an assortment of energy funds in their place.

So before the tryptophan and football take hold on Thursday, stop and consider whether your portfolio is positioned for the future or the past.

Thank you for reading ETF Global Perspectives!

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