Extend and Pretend

Wednesday’s much-anticipated decision by the FOMC to raise rates and end the second longest rate hike “dry spell” since the inception of the Federal Reserve has us wondering about how much the world has changed since then and what it could look like in 2016?  The last time the Fed hiked rates the Iraqi insurgency was raging.  While the backdrop might be different, one perennial holiday tradition is the release of bullish outlooks from equity strategists for the upcoming year even as more sober investors sent stocks reeling late in the week as the Fed began tightening monetary policy while a number of indicators are flashing trouble ahead.  Even though Janet Yellen’s Christmas gift to the markets might be more confusion as investors try to manage their year-end reallocation, we’re determined to provide some holiday clarity by turning to our ETFG Quant Movers Report to help investors separate signals from noise and determine whether 2016 will be another year to forget.

It seems that most market prognosticators are simply using their own version of “extend and pretend” by taking their now year-old forecasts for 2015 and replacing the 15 with 16 hoping to erase all memory of the fact that average forecast for 2015 was a 10% gain.  Goldman Sachs, Merrill Lynch and Fundstrat so far have carried over their 2015 forecasts into next year while UBS, RBC and Morgan Stanley have adjusted their previous predications up or down by 100 bps or less as most seem to acknowledge that earnings growth will have to replace multiple expansion although neither was present this year.  That might be reason enough to take their recommendations with a grain of salt although a glance at the charts might give the forecasters a boost heading into the end of the year.   Even as the S&P 500 found new ways to disappoint last week, our technician friends would be the first to point out that it’s quickly advancing towards strong prior support at the 2000 level that has helped to restrain it in the past while asset allocators could find hope as the Russell 2000 index outperformed its large cap cousins.  Friday’s quant movers report tells us that it might be too soon for a Christmas miracle and that last week’s outperformance by small-cap stock indices was more about not holding Apple.

Some of the funds that saw the biggest gains in their weekly fundamental score (as their prices fell) on Friday were 2015’s biggest winners in the megacap space including the Vanguard Mega Cap Growth Fund (MGK) or the SPDR DJ Industrial Average ETF (DIA) with a 124% and 79% increase in their respective scores and their losses help explain why small-caps “outperformed” last week.  Both funds have large allocations to Apple which suffered a 6.3% retreat for the week as analysts expect that the iPhone sales might be in danger of plateauing in 2016 which sent investors scurrying for the exits and left the stock in the red for 2015.  At 4.2% of DIA and nearly 9% of MGK (not to mention the largest single stock in the S&P 500), Apple’s movements can have major implications for broader markets and the pain is being felt throughout the markets.  Apple’s performance sent tech funds like the Technology Sector Select SPDR (XLK) with a nearly 15% allocation soaring at the start of the year and high up on our list of top behavioral scoring funds.  Now XLK can barely crack the top half of funds we screen at ETFG and those who visit Barron’s review of forecasts for 2016 should note that technology stocks remain a favorite pick for nearly all the major investment shops.  As to small-cap stocks outperforming for the remainder of 2015, Santa might have a big lump of coal for you this week as the % of the NYSE currently trading above their 200 day moving average hovers at 25% while the larger market cap S&P 500 actually rose slightly w-o-w to 40%.

One thing not on any forecasters radar would be those international equity and other inverse dollar positions we’ve discussed over the last few weeks, most notably emerging market equities where the iShares Emerging Market Equities Fund (EEM) held on to most of its gains from the start of the week to outperform the S&P 500 by more than 380 bps.  While that performance helped keep EEM on our list of 100 top behavioral scoring funds, the real breakout stars for the week were a series of smaller funds with a more “balanced” allocation that reduces the weighting given to Brazilian stocks in favor of smaller markets.  It’s not surprise that a fund like the Guggenheim MSCI Emerging Markets Equal Country Weight ETF (EWEM) is on the list after its weekly Behavioral Score surged more than 63% last week thanks to a smaller allocation to Brazil although the fund does have a larger overall allocation to Latin American stocks thanks to 300 bps overweight’s to Chile and Colombia.  The biggest difference between EWEM and EEM is the position of Chinese equities where EWEM holds just over 4% compared to 25% for EEM and for those who think that’s a bridge too far; you should consider one of the other big movers last week, the SPDR S&P Emerging Markets ETF (GMM.)  In fact, GMM has over 30% of its portfolio in Chinese equities and nearly 70% in Asian equities overall including a nearly 12% position in Indian stocks which were among the biggest winners last week.

While extend and pretend might be a good strategy for some, how confident are you about where 2016’s winners will come from?

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