Monday, February 29, 2016

Morning in America

Break out those miniature American flags because after the strong Durable Goods and GDP reports, it’s time to declare that “It’s Morning Again in America!”  We know, that’s a little extreme but 2016 is quickly becoming the year for extremes and exploiting divergences is a good way to make a living in a market like this.  Investors who at the start of the year were quick to conclude that the Fed had missed its mark and loaded up on “safe haven” plays like utilities and gold miners saw some of those gains eroded on Friday following the better-than-expected GDP print and left us wondering how long before they go rushing in the opposite direction? The financial media will be quick to conclude that the economic worm has turned and that it’s time to go bullish after three strong weeks have pushed the S&P 500 above the Danger Zone at 1880 with although on the whole the situation was more complicated as equities stumbled and closed out the day in the red on profit taking.  With equities at a point where the situation could go either way, we turn to our ETFG Behavioral Top 100 Scorers to see if they can shed some light on whether a new day is truly about to dawn.

No one is disputing that manufacturers desperately need a win after the Manufacturing ISM Index contracted for the fourth straight month in January albeit at a slower rate as improvements in production and new orders couldn’t overcome the slowdown in exports or the drop in employment.  Naturally you would think that Thursday’s strong beat on the Durable Goods report would have sent the industrial sector surging and left our weekly ETFG Quant Report looking like a “who’s who” of manufacturing ETF’s, but instead the report shows only one industrial ETF with a big enough score change to merit inclusion on our short list.  The reason why is fairly obvious; in January when most investors were rushing into defensive favorites like the Utilities Sector Select SPDR (XLU), a few more intrepid souls began buying when there was still blood in the streets, slowly pushing up scores for some of the larger industrial funds.  One of the dirty little secrets of the market’s rally over the last few weeks was that it was being led by the sectors you would consider to be least likely to spark a major move higher, with the Industrials and Materials Select Sector SPDR Funds (XLI and XLB) up 9.25% and 12.16% respectively from their lows on January 20th while the S&P 500 was up a mere 4.8%.  However despite that strong performance, just five of the twenty-two industrial funds we rank (levered and inverse excluded) make the Behavioral Top 100 list which is still dominated by utilities and low volatility funds.

Three of the funds are broad sector funds located close to the bottom of the list with the iShares U.S. Industrials ETF (IYJ) coming in at #69 while the Guggenheim S&P 500 Equal Weight Industrials ETF (RGI) is at #77 and the Fidelity MSCI Industrials ETF (FIDU) is at #83 while XLI is conspicuously absent from the list all together.  Not exactly awe inspiring.  Comparing these three funds to XLI, you find very little of note beyond a slight underweight towards transportation stocks and one of the sector’s worst performers, Boeing (BA), along with a slightly overweight to 3M (MMM.)  As an equal weight product, RGI naturally has the lowest allocation to BA which along with an allocation to ADT has helped the fund outperform its peers so far in 2016 with a YTD return of -.72% compared to -2.51% for IYJ.

The biggest non-surprise of them all is that the top ranked industrial fund is in a market which in an election year can be considered as a sacred cow with the iShares U.S. Aerospace & Defense ETF (ITA) holding court all the way at #42.  ITA remains mired in the red with a -4.92% return so far in 2016 (thanks again Boeing) and while Honeywell’s potential acquisition of United Technologies is the deal on everyone’s list; we think investors are thinking ahead to a time when you take growth wherever you can find it.  Two of its strongest performers are Sturm Ruger (RGR) and Smith & Wesson (SWHC) and although it’s possible that Bernie Sanders might have mentioned cutting the defense budget, for every other candidate in 2016 it’s a sine qua non and the market knows it with five of ITA’s top ten positions in positive territory.

So while we remain skeptical of a new dawn for American manufacturing, for those bullish investors who think the S&P 500 might see 2000 or even 2075 in the near future, Friday’s biggest reveal wasn’t the latest GDP report or the rise in personal incomes but that the baton of sector leadership might soon be handed off from industrial to financials, which along with the healthcare sector remains mired below its fifty day moving average.  Investors and generals are equally guilty when it comes to “always fighting the last war” because no one has felt the market’s wrath over the Fed’s actions more than bank stocks which experienced a short-lived rally last fall only to get demolished in December when investors began to fear that the global downturn would turn 2016 into an instant replay of 2008. To show just how dire the situation has become, even after Friday’s big rally you can buy Bank of America (BAC) and Citigroup (C) at a price-to-book multiple of .56 which according to Bloomberg is only slightly BELOW the going rate for China’s undercapitalized and overly stressed “Big Four” banks!  No wonder that the only financial fund to make the Behavioral Top 100, the PowerShares KBW Property & Casualty Insurance Portfolio (KBWP), represents the insurance sector which employs less leverage and subsequently has less volatility.

But the sharp Treasury sell-off following Friday’s GDP report could signal that investors are starting to wonder if they were too quick to get defensive after top investors and economists pummeled Janet Yellen and the rest of the FOMC for hiking rates last December.  After running en masse into defensive plays like utilities, treasuries and gold, could we see a similar rush back into those funds most likely to benefit from easing concerns over economic output?  If mega-banks like BAC and C are going be the biggest winners, our Grey Market Report shows the most concentrated holder of those names is the PowerShares KBW Bank Portfolio (KBWB), which with just 24 holdings and 84% of its portfolio in bank stocks saw a 1.76% boost on Friday and more than a 10% boost in its Behavioral Quant score for the week.  If you like banks but want a bit more diversification, the iShares U.S. Financial Services ETF (IYG) with 116 names might be more to your liking.

Thank you for reading ETF Global Perspectives!

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