Monday, February 22, 2016

Stop the ride, I want to get off!

We’re starting to wonder if the biggest winner of 2016 isn’t going to be Donald Trump or the recently “vindicated” John Hussman but Johnson & Johnson (JNJ), maker of Tylenol, antacids and a bunch of other stuff that we’re all going to need to get through a year that’s seen the world turned upside down.  While the political arena continues to contemplate that the next presidential election might feature two extreme candidates unlike any previous election, last week’s failed attempt by the S&P 500 to break out of a new downtrend channel left investors to face the fact that it’s the Feds world, we just happen to live in it.  Investors and momentum managers have every right to be confused; since rate hike fever began in earnest last summer, stocks have been through three major trend changes, two down and one up, with each followed by a multi-week consolidation that for retail investors has either been a great spot to take profits and get-out or worse, let themselves be convinced there’s nothing to be done but buy the dip and hope it turns around by the time they retire!  No wonder that our fund flows and ETFG Quant Movers Reports are telling us that investors are fed up and sticking with low volatility favorites rather than trying to time the market.

Instead of pointing to the relatively weak volume that accompanied last week’s rally (at least compared to the selling that predominated at the start of the month) or the S&P 500’s ability to regain 1920 or just any number of technical data points, Exhibit A for our case of investor exhaustion is the fact that low volatility funds continue to be among the biggest asset gatherers.  The iShares MSCI USA Minimum Volatility Fund (USMV) and the PowerShares S&P 500 Low Volatility Fund (SPLV) pulled in so much new capital that we’re starting to wonder if those two funds are on the verge of becoming the default core holding in every investor portfolio.  It’s not hard to see what investors love about the two; both funds are only down slightly in 2016 with USMV off 1.05% compared to a 1.18% loss for SPLV and nearly a 5.9% loss for the S&P 500 while simultaneously carrying some of our lowest ETFG Risk Rankings.  That strong performance involves more than just missing the downside; both funds were up over 2% this week and saw surging ETFG Behavioral Quant scores.  We’ve talked about both funds before plus their success has made them widely copied so what’s in the secret sauce isn’t much of a secret anymore but allocations to strongly performing REIT and consumer staples names (Realty Income and Campbell Soup) have helped keep these two on the right side of the S&P 500 while their trend-following or actively managed peers have stumbled in 2016.  You don’t need a crystal ball to tell you which retail investors would prefer in troubled times; a 1% loss with USMV or a negative 7.8% paper return with PowerShares DWA Momentum Portfolio (PDR)?

We know that at the end of the day, the only question that matters is just how much money are we talking about here?  Over the last three months, USMV has taken in $1.92 billion (yes, with a B) while smaller rival SPLV has had to be contented with a mere $755 million or so but we’re still talking double digit growth here.  Compare that with the SPDR S&P 500 ETF (SPY) which has taken in over $9 billion, although we’d like to point out that at least SOME of that share creation has been for shorting purposes and most of it came in the last few weeks of 2015.  Even relative newcomers to the low volatility/quality names space like the O'Shares FTSE U.S. Quality Dividend ETF (OUSA) have been able to pull in big dollars, in this case $37.55 million (doubling its asset base), which helps beget a virtuous cycle as investors clearly prefer bigger and therefore (supposedly) more stable funds in volatile markets which of course results in the fund becoming even larger and more (still supposedly) stable, etc.  And while institutional investors and our CFA comrades-in-arms are still concerned about the outcomes of having everyone rush into one active beta strategy at the same time, equity funds aren’t the only ones benefiting from the desire for “safety” and the money flowing into low volatility funds might be a drop in the bucket compared to what could be brewing with bond funds.

Exhibit B in this discussion would be the steady amount of money finding its way into bond funds, including a surprisingly large amount into some of the “riskier” names.  Investors seeking safety in bonds is nothing new, but what makes this movement into bond funds so remarkable is how it comes against the backdrop of not just concern over the stability of credit markets brought on by the rise of ETFs but the near loathing so much of the retail investment community has had for the asset class of late.  Bond funds did their job well in 2008 but too many advisors stayed defensive during the early stages of the bull cycle and probably still have some ringing in their ears from angry clients who, like all angry clients, want 100% of the upside (even if the market is down) and none of the downside.  But bond funds have been benefiting from the “take me out” trend although we’re starting to think that investors are either shifting their mental benchmarks for what they consider to be the “market” or how to get that 100%.  Compared to some of the low volatility funds, the iShares Core U.S. Aggregate Bond ETF (AGG) pulling in a little over 8% in new assets in the last three months and a mere 2.74% in February isn’t too impressive and while we will grant that AGG is a large fund, that inflow pales in comparison to the iShares iBoxx High Yield Corporate Bond ETF (HYG) which pulled in $770 million just last week for an almost 6% asset gain.

So like the early stages of the last bull market, investors could be looking to high yield bonds as an easy way to gain equity like exposure with less volatility although a simpler answer would be that traders have decided that high yield spreads, trading close to 2011’s high’s, are likely to fall if market stability resumes and if they don’t, how much further could they widen without a major equity meltdown?  But then again, there’s a significant chunk of the market that’s planning for more trouble (or deflation) ahead with data from Factset showing YTD inflows into the iShares 20+ Year Treasury Bond Fund (TLT) at nearly the same level as the more defensive iShares Short Treasury Bond (SHV) and nearly 70% greater than AGG.

Clearly some out there aren’t afraid of duration, or at the very least, they’re more afraid of living in Janet Yellen’s market than they are about interest rate risk.

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