Monday, March 7, 2016

Déjà Vu All Over Again

Diligent chart watchers are surely starting to develop a serious case of what the great Yogi Berra would’ve referred to as “déjà vu, all over again.”  Raise your hands if this seems familiar to you; after a pullback of somewhere around 10%, the S&P 500 finds support and begins a six to seven week rally where it seems each week the market closes at its high while the low is only just below the prior week’s close?  It should seem familiar because it’s happened twice now in the last two years, first following the “Taper Tantrum” of 2014 then again last September in the build-up to the first rate hike.  Like some distant moon, the market seems to be tidally locked into an unchanging pattern thanks to Janet Yellen’s policy of “data dependency” as it digests major economic releases approaching a major FOMC meeting, looking for clues to whether tighter monetary policy will continue.  Last Friday’s employment report was no exception and from slight changes in our Quant Report, we can’t help but wonder if the market will be stuck repeating this same pattern for a third time.

Given the origins of this rally which has pushed the S&P 500 not just back above its 50 day moving average but within just 24 points of the 200 day, it wasn’t much of a shocker that our list of Behavioral Gainers is dominated by “johnny-come-lately” emerging market equity funds that so far have been overlooked by investors.  The market didn’t begin to find its legs until approximately the same time as the Citi Economic Surprise Index dropped to within a few points of its 2015 lows while economists debated whether the Fed might have to abort its plan for hiking rates.  So in that “bad news is good news environment”, no one suffered from shifting expectations as much as the PowerShares DB US Dollar Index Bullish Fund (UUP) with close to $300 million, or 26.2% of the fund’s assets, leaving in the last three months.  And while the iShares MSCI Emerging Markets Fund (EEM) has benefited strongly from the dollar’s rout, the biggest winners are those Latin American ETFs that we discussed on January 25th just before the rally began in “Just More Pillow Talk” with three of the top ten behavioral scorers coming from that category while a host of other EM markets help round out the list.  So again, it’s no wonder that the tiny KraneShares FTSE Emerging Markets Plus ETF (KEMP) saw a 175% increase in its behavior score while the iShares India 50 ETF (INDY) and the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV) were also big movers on the week, but are investors just playing the old game of “buy high, sell low?”

Economic forecasting is a tough gig but the recent improvement in expectations is undeniable and Friday’s employment report was just the icing on the cake as the Citi Economic Surprise Index has gone from a score approaching -60 at the start of February to almost positive territory on Friday with the question on everyone’s mind being how does that play out in the heads of the FOMC?  Most commentators will point out that the current make-up of voting members still has a Dovish leaning with the big concern over whether the transmission of expectations from Wall Street to Main Street could be derailing the recovery.  It’s easy to make a case for the Fed choosing a “wait and see” approach at their gathering next but the more important question is whether the Fed can continue to stall if the economic situation doesn’t reverse itself in the near future.  With stabilizing oil prices, rising personal income and spending, rising employment and with the year-over-year change in core CPI above the 2% rate not to mention that the headline unemployment rate is perilously close to the 4.7% lower boundary the Fed pegged in their last dot-plot, it’s becoming hard to see how a supposedly data-dependent body could not continue hiking rates later this year.  Putting it all together, it could mean a serious reassessment of equity risk and a return to the stronger dollar that followed both of the last rallies.

But emerging market funds aren’t the only ones that have benefited from a weakening dollar and investors in another of 2016’s biggest winners are already taking profits and moving on.  The Employment report didn’t do much to dent the iShares MSCI Brazil Fund’s (EWZ) upward momentum as it closed the day up 5.27% but even that was just a drop in the YTD bucket.  In fact, EWZ has gone from being oversold on January 21st to being overbought on March 4th while not only moving to the top of the ETFG Behavioral Score List but also racking up a 44.2% gain in the process!  Now contrast that with the recent performance of the Market Vectors Gold Miners Fund (GDX), up over 52.6% in that same period and which started Friday with a strong gain only to see it erode throughout the day into a slight loss which is becoming all too familiar as the fund has seen its momentum ebb since mid-February.  Gold bugs will argue that any pullback in the miners is a temporary setback (don’t they always?) as further easing by the Fed is inevitable, but if the simplest answer is the correct one, it’s more likely that the recent improvement in economic data is likely to boost rates and lend further support to the dollar.  If that does prove to be true, then the weakness in the highly volatile miners was just the canary in the coal mine.

But to continue quoting that great man, “it ain’t over, till it’s over” and with a light schedule for the week, the market should find little to dent its upwards march besides a speech by Fed Vice-Chair Stanley Fischer on Monday afternoon.  A push higher would continue that well-established cycle we seemed doomed to repeat as the last two rallies both entered their 4th week around 2030 and proceed to march higher.  But there the narrative in our story begins to change because in 2014, the S&P pushed its way to a new high while in 2015 the market stalled out just beneath that level after losing steam as it passed beyond the 50 week moving average which currently sits at 2034.  Will this time be different or is it really just déjà vu all over again?

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