Monday, March 21, 2016

Gas on the Fire

Another layer of snow for the Eastern Seaboard on the official start date of spring means that Mother Nature, like the FOMC, is now also in danger of running behind the curve.  Most Fed watchers will tell you that Janet Yellen and the rest of the FOMC are walking a fine line right now, fearful of keeping monetary policy overly accommodative and further skewing attitudes towards risk while simultaneously trying to avoid raising rates too precipitously and sending the economy on a downward spiral.  And we get that being “data dependent” means the Fed will always run the risk of being late to the party but we’re starting to wonder if the Fed is concerned about tightening too quickly and repeating the economic relapse of 1937 that it’s clouding how they view the present.

While economic output remains below the pre-Lehman levels, fuel prices have begun to stabilize and a falling dollar is boosting commodity prices, which along with the recent news that core CPI is running at well over 2% would seem to indicate that inflation is above the Fed’s target or at least that headline CPI will be above 2% in the not-so-distant future.  All of which makes the latest dot plot from the FOMC further undercutting their rate hike plans for 2016 a real head scratcher unless the specific goal is to put more downward pressure on the dollar and thus boost the prospects for even more inflation.  Whatever the reason, the markets loved the dovish outlook but comparing some of the best performing funds last week to our latest ETFG Quant Movers Report and our list of Behavioral Top Performers, we’re wondering if everyone was a little too quick to throw in with the Fed.

At the risk of oversimplifying our situation (even more than we already have) into a simple binomial, the Fed ultimately will either be right or wrong about holding off on raising rates at their most recent gathering, but given the fortunes lost in the last seven years by betting against their willingness to keep rates low, it would stand to reason that investors would embrace the new dot plot and our biggest quant movers last week would be beneficiaries of the Fed’s recently adjusted outlook.  The PowerShares DB US Dollar Index Bullish Fund (UUP) was hit hard by the plan to scale back the anticipated rate hikes and is now back to last October’s lows but despite that loss you won’t find some of the year hottest performers like the Market Vectors Gold Miners ETF (GDX) on our list of biggest movers despite notching a strong 3.15% gain for the week.

In fact, take it as a sign of how far the emerging market and natural resources rally has already come that only one commodity fund, the Global X Copper Miners ETF (COPX), made Friday’s list of top behavioral movers while only country fund directly tied to the commodity complex, the iShares MSCI Chile Capped ETF (ECH), made the weekly list after underperforming most Latin American ETF’s over the last month.  The “why” is fairly straightforward; we’ve talked before about using the top behavioral scorers as a sort of contrarian indicator and most Latin American funds or any fund offering exposure to materials and mining names or countries that depend heavily on natural resources (and offer negative dollar exposure like Australia or Canada) are already in the Behavioral Top 100.  There’s no denying that the funds making up the top 100 have been some of the primary beneficiaries of the Fed’s actions with ILF or the iShares MSCI Emerging Markets ETF (EEM) having gone from being oversold to overbought in just two months and were already showing signs of flagging before last Wednesday’s announcement as their prices encounter their still declining moving averages.

But if many ways all the Fed did on Wednesday was to breathe a little life back into a slowly ebbing fire into some EM funds, their actions were more like pouring gasoline onto a pile of oily rags in the China A-share market where the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) kicked its own rally into higher gear with a 6.84% advance last week.  Most were quick to believe that the rally in China was ignited by comments made by Chinese Premier Li Keqiang at the National People’s Conference on the need to continue economic reforms while at the same time arguing the government still has the firepower to ensure GDP growth above 6.5% but we’re not so sure that it’s just a coincidence.

It’s no secret that Chinese reserves have been under pressure for years with some of the most bearish investors debating whether the government has already passed the point of no return while Moody’s recently downgraded their outlook on Chinese debt.  Given that nearly every hedge fund manager thinks the Yuan will continue to lose ground, it stands to reason that anything that simultaneously reduces the allure of the U.S. dollar to Chinese investors and eases the burden on the PBoC is welcome news to the China bulls.  And looking to kill two birds with one stone, the biggest behavioral gainers for the week were EM funds that offer both heavy China and Latin American exposure with the PowerShares S&P Emerging Markets High Beta Portfolio (EEHB) and Guggenheim BRIC ETF (EEB) seeing their behavioral scores surge last week while the other side of the column was populated with Japanese funds hit by a surging Yen.

In fact, the only outlier in our Quant Movers report seemingly not affected by dollar woes is the healthcare sector where the spillover from Valeant Pharmaceuticals 61% drop last week continues to afflict investor sentiment and sent investors scurrying for the exits.  The pullback in pharmaceutical names has been so intense that even broad-based funds like the iShares Healthcare ETF (IYH) saw a 34% pullback in its behavioral score last week while no domestic healthcare funds make the Behavioral Top 100.  That alone might make it tempting to offer a contrarian argument in favor of healthcare stocks given that the sector still makes up more than 14% of the value of the S&P 500 and could be a good “tag-along” bet if equity sentiment continues to improve, but if there’s one lesson to be learned from the fallout in energy names, it’s that cheap stocks can always get cheaper.  Sometimes, there’s something to be said for sticking with the herd.

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