Monday, January 25, 2016

Just More Pillow Talk?

So all it took to get investors off the sidelines and back in the game after one of the worst Januaries in market history was a little pillow talk from Mario Draghi and the ECB on Thursday about expanding their stimulus efforts to help equity markets find their footing, although the S&P 500 running into a big pocket of support between 1850 and 1880 probably didn’t hurt either. Mario might have poured the gas on the fire to help the rally get started, but it was Chairman of Aramco who lit the match when he discussed that crude oil beneath $30 a barrel was “irrational” and predicted higher prices by the end of the year.  No promises were made on how we get there but that comment was all investors needed before buying energy stocks with both hands and sending the Energy Select Sector SPDR (XLE) up over 4.4% on Friday.  After two positive days, talk about buying the dip is already back in vogue although we haven’t seen anyone saying this is the turning point, but what we have noticed is that despite Friday’s strong action, energy funds are nowhere to be found on our daily list of biggest quant movers.  And while energy funds may have been conspicuously absent from Friday’s report, international funds were well-represented although who made the list of biggest percentage movers was a bit of a head scratcher.

Under the column heading of “not surprised at all” you’ll find hedged Japanese equity funds from WisdomTree including the WisdomTree Japan Hedged Tech, Media and Telecom Fund (DXJT) and the WisdomTree Japan Hedged Health Care Fund (DXJH) which thanks to a nineteen point improvement in its behavioral score now sits atop the ETFG Behavioral Ranking list!  Promises of more government largess have a way of sparking rallies but noticeably absent from the list (but still falling into the “not surprised” column) is WisdomTree’s flagship fund in that space, the WisdomTree Japan Hedged Equity Fund (DXJ), which was nowhere to be found despite a 50% improvement in its behavioral quant score on Friday. What’s not surprising about it is that DXJ has been suffering mightily since Japanese equities and the U.S. dollar lost their mojo’s at the same time last year and it’s been a rough ride for DXJ ever since; in the last month alone the fund has seen over $768 million in outflows along with a two-third drop in its behavioral score!  Strong price momentum helped lift DXJ’s behavioral score on Friday but at just a quarter of what tiny DXJH is sporting, it might still be too soon to tell if a new trend is emerging.

What does have us surprised is that investor’s enthusiasm for easy money lifted more than just international developed stocks as our list of biggest percentage changes includes a handful of Latin American funds including the iShares Latin America 40 ETF (ILF) and the iShares MSCI Chile Capped ETF (ECH) and to be honest, we’re not sure why.  It’s no secret that Latin American funds have struggled over the last few years and even with Friday’s rally, ILF is off more than 60% from its peak in April of 2011 and traders trying to time the fund know it’s more difficult than jumping on a moving train thanks a standard deviation that’s almost twice as high as the S&P 500’s over the last five years.  But that volatility might be exactly the reason why ILF and ECH saw a more than 70% jump in their behavioral scores on Friday as more intrepid investors hope that end of the great Fed Bull market means quick price gains for the most beaten-up international sectors.

Another possibility is that the more global macro oriented set are thinking about through the consequences of easy monetary policy and currency movements and are starting to accumulate positions in the region hoping that European and Japanese investors, lured by higher interest rates, might takeover America’s role in supplying capital to Latin America and so a quick trade becomes a more long-term play.  It’s not surprising that investors have been avoiding Latin American stocks for so many years; most headlines on the region don’t stray too far from politics, corruption scandals or drug violence but much of that political instability is the direct result of the fallout from the end of the commodity supercycle and any hope for a bottoming out of asset prices might provide the catalyst investors need to get excited again.  And oil wasn’t the only commodity to find its footing last week as investor enthusiasm for hard assets spilled over to other deeply oversold resources like copper and coal and sending broad natural resource funds like the WisdomTree Global Natural Resources Fund (GNAT) up over 3.5% on Friday.  No doubt ILF and ECH have their fair share of commodity exposure but the real attraction of the both funds is that they can offer exposure to currencies that the dollar actually lost ground to last Friday.

Even the greatest currency traders will tell you that it’s impossible to predict every variable in the relationship between two free-floating currencies which is why it’s probably easier just to put your money behind the idea of mean reversion and focus on relationships that have reached extreme levels.  The Yen and Euro both lost ground against the dollar last week but the Brazilian Real, Chilean and Mexican Pesos both made headway against Uncle Buck on Friday with it losing more than 1.3% against each currency.  1% is just a drop in the bucket against what they’ve lost with the dollar up over 46% against the Mexican Peso in the last three years, 52% versus the Chilean Peso and more than 100% against the Real.  That sort of extreme outperformance might be attracting speculators who believe that even the hope of stabilization in Latin America can send their currencies skyrocketing and offer some serious returns in what could be an otherwise flat-to-down year for equities; why else would a fund like ECH, with more utilities than commodities exposure, be up almost 4% on Friday?

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