A Large Cap World

To start this month, the S&P 500 recorded four consecutive +/- 1% days for the first time since August as investors returned from a long holiday weekend only to find their long dollar positions in jeopardy.  News that Mario Draghi and the ECB were saving their big guns for when they were truly needed sent the Euro surging and the markets spiraling downwards so that by Thursday night, the S&P 500 was nearly flat on the year only to have it bounce back by over 2% on Friday and leave it largely unchanged for the week.  The S&P 500’s minute change might recall those words of Shakespeare when Macbeth spoke of “sound and fury, signifying nothing” but for those whose livelihood depends on delivering outperformance, it was a desperate struggle to stay on the right side of the line for 2015.  For those with a broader mandate or long-term view, it’s a chance to peel back the curtain and see a market more desperately leaning towards one side than ever before.

Friday seemed to be one of those days where you had to try hard to lose money as the rising tide lifted all boats.  Outside of the energy sector, a heat map would show almost nothing but green no matter the asset class as domestic and international equities, long-term bonds and even commodities were higher on the day and those who visit our ETFG Quant Movers page won’t find much that surprises them.  Among the biggest Quant movers on Friday were those funds with heavy financial exposure including the PowerShares S&P 500 Low Volatility Portfolio (SPLV), the SPDR S&P Insurance ETF (KIE) and the First Trust Financials AlphaDEX Fund (FXO) as November’s Employment report seemed to guarantee a rate hike in two weeks.  Switching to the ETFG Behavioral Top 25, both SPLV and KIE have seen such a strong increase in their scores that they now make the top 10 along with three other financial funds but the more you study the list, the more apparent it becomes that the divide between large and small, growth and value funds has reached a very dangerous level.

One thing that could make even a casual observer anxious is that the number one spot is currently held by the iShares Russell 1000 Growth ETF (IWF) reflecting that Friday’s rally was very much a large cap affair as the iShares Russell 1000 Value ETF (IWD) continued to lag the broader markets with a 1.6% advance compared to the S&P 500’s 2.05% and IWF’s 2.12%.  But to understand how truly extreme the situation has gotten, you need to consider that nearly 1000 bps separates the two funds' 2015 returns as IWD continues to be weighed down by a 12% allocation to energy stocks even though Friday’s rally included mega-cap energy names like ExxonMobil and Chevron.  The average actively-managed, large value fund manager is down 1.57% in 2015 compared to a -1.69% loss for the Russell 1000 Value Index. So it’s possible that the two day rout which brought the S&P 500 back to its starting point for the year was an irresistible opportunity for fund managers looking to catch ahold of a trend and potentially avoid another year of underperformance and even a minor bump in exposure to some of 2015’s strongest tech names like Microsoft could mean making it into the upper half of managers for 2015 and avoiding a costly job search.  Small wonder then that only three international funds make the top 25 list while there are seven funds with the word “growth” in their names and while more than 52% of the S&P 500 is above its 200 day moving average, only 36% of the NYSE can say the same.

Investors looking for divergences that might signify a new trend should keep their eyes focused on those dollar and interest rate sensitive assets that somehow found a way to put more points on the board last Friday and there were a lot of them.  A number of long-treasury funds including the iShares 20+ Year Treasury Bond ETF (TLT) and the Vanguard Extended Duration Treasury Fund (EDV) gained on the day as investors bet that long-rates will be less susceptible to rate hikes, but the strongest performers were among the most unloved assets in the bargain bin.  Even as the dollar managed to recover some of its prior losses, a number of agricultural commodity and precious metals funds continued to outshine the broad equity market in a sign that some investors are planning ahead for what comes after the rate hikes.  It might seem counterintuitive, but with the ECB holding off on deploying its heavy artillery some traders might have decided to lock in their long dollar profits before the upcoming FOMC meeting and the end of the calendar year, potentially restricting any further dollar gains.  Among the biggest movers was the Market Vectors Gold Miners Fund (GDX) whose 5.33% return on Friday added to the strong performance earlier in the week and brought the fund’s total gain to just under 10.3% for the week on strong volume while it’s ETFG Behavioral score has risen over 30% in the last two weeks.  Even the SPDR Gold Trust (GLD) and iShares Silver Trust (SLV) gained 2.22% and 3.05% on Friday respectively as investors wager the Fed’s rate hikes will be shallow and short lived.

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