Monday, November 2, 2015

Land of Confusion

Another week and another push higher by the S&P 500 but as tempting as it might be to say that the pattern that’s dominated the markets over the last few weeks remains unchanged, a subtle shift is beginning to take over investor behavior.  We’re keeping a close eye on a number of trends, but the weak action in the markets last week serves as a symptom of the shift. Instead of the strong late week rally we’ve come to expect, the entire gain for the week came from Wednesday’s powerful move after the FOMC report.  Profit taking later in the week then left the S&P 500 up just .2%.  Maybe investors are just tired of feeling like travelers in a land of confusion but we’ve noticed a common thread in our list of biggest ETFG Quant Movers, a focus on fundamentals like earnings growth that has us wondering whether the market is beginning to look beyond the Fed and back to fundamentals.

While our list of 25 Top Behavioral Scoring Funds again is dominated by biotech names, our list of funds with the biggest % change in their weekly behavioral quant score reflects the shifting investor focus on profitability with four funds seeing major momentum changes.  Three of the four funds have a pharmaceutical focus with the PowerShares DWA Healthcare Momentum Portfolio (PTH), PowerShares Dynamic Pharmaceuticals Portfolio (PJP), iShares U.S. Pharmaceuticals ETF (IHE) being joined by only one broad based fund, the Fidelity MSCI Health Care Index ETF (FHLC.)  Critics can be forgiven for thinking this is just an overdue bounce after all the negative press the sector has endured thanks to Valeant and Turning Pharmaceuticals, but there may be more to this move than just sentiment.  Quarterly earnings growth for the S&P 500 is currently a negative 2.2% with nearly 70% of the constituents having reported, but it’s a very different story for the healthcare sector which leads the market in the number of companies reporting upside earnings surprises and which is only trailing the tiny telecommunications sector in earnings growth!  Thanks to strong earnings from names like Pfizer, Gilead and Amgen, the quarterly earnings growth rate is now at 13.6% so small wonder that investors funneled over $247 million into healthcare funds in October, outpacing every other equity sector that month!

Even more interesting to us than the amount of money flowing into the healthcare sector or the number of funds on our list of quant movers is the nature of the funds that make it up.  All four of the funds on the weekly behavioral movers list held large allocations to Allergan (AGN) although given that stock is a large component of even the much broader XLV it would be more remarkable if they didn’t own it.    However only FHLC held an allocation to the week’s biggest mover, AbbVie Inc. (ABBV), up 18.3% last week on a major earnings blowout.  That exposure for FHLC reflects the fact that it’s the only fund of the four to offer broad healthcare sector exposure with the other three major movers all being highly concentrated pharmaceutical funds with anywhere from 23 (PJP) to 46 (PTH) holdings.  Concentration like that usually is a cause for concern given the amount of stock-specific risk that it adds to the portfolio but the common holdings among the funds is hardly a pharmaceutical rogue’s gallery.  The common holdings are mega-cap names like Johnson & Johnson, Pfizer and Bristol Meyers Squibb meaning either investors are buying funds without carefully examining the holdings or that they are looking to add exposure to the more consistent earnings of the top names in the sector.  Adding that exposure has paid off this earnings season as companies with upside earnings surprises have delivered strong outperformance in the two days leading up to the earnings release and in the two days after the announcement.

But if there’s one sector that’s feeling the pinch it’s the financials where the Financials Select Sector SPDR (XLF) continues to struggle for traction.  XLF and the broader sector lost ground after a promising start to the week when the somewhat hawkish FOMC statement was seen improving the odds for a future rate hike ran smack into more weak data points including Thursday’s GDP report and Friday’s Personal Income release.  Even the possibility of a bout of merger mania couldn’t ignite investor interest with Thursday’s announcement by Key Corp (KEY) of its acquisition of First Niagara Financial (FNFG) sent Keys’ stock plummeting down 10.65% in the next two days and dragging large holders like the PowerShares KBW Bank Portfolio (KBWB) down with it.  But investor pragmatism is again on display as the financial sector has failed to “wow” with its third quarter earnings reports.  While earnings have grown slightly faster than many analysts forecasted on September 30th, none have reported sharply higher earnings surprises (which capture investor enthusiasm) like healthcare stocks while disappointments from titans like Morgan Stanley and Goldman Sachs remind investors of the troubled state of the industry.  Investors looking for one sector that could stand to benefit the most from improving sentiment need look no further.

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