Monday, March 14, 2016

Super Mario to Save the Day

The bulls had another reason to say “thank God, it’s Friday” as the latest stock rally celebrated its one month anniversary by sending the S&P 500 up 1.6% on the day and taking the one-month return to over 10.8%!  They even pushed the market over its 200 day moving average for the first time in 2016!  Yes, the market is firing on all cylinders and we have “Super Mario” to thank yet again.  After a sideways Thursday, it turned out traders just needed a full day to digest Mario Draghi’s and the ECB’s latest “final” plan to help jumpstart lending and provide financial salvation to Europe so after trying to wrap their heads around the ECB’s conflicting statements and who stands to win from TLTRO II, they decided to just go with their gut and buy-buy-buy.  And while it’s safe to assume that hedged international equity funds were the obvious losers on Friday, our ETFG Quant Movers Report shows that one of the market’s largest sectors has finally decided to get into the game and was just what the doctor ordered to keep the rally alive for another week.

Traders weren’t the only ones who needed a full-day to pick apart the details in Mario Draghi’s latest plan to save the EU but even we could figure out that the biggest winners were going to be those EU banks that have felt their net-interest-margins being squeezed on both ends and ultimately the funds that hold them.  Two of the biggest winners on Friday were the iShares MSCI Germany ETF (EWG) and the iShares MSCI EMU Index ETF (EZU), whose behavioral scores rose 40% and 44% respectively thanks to their large exposure to European financial institutions which, along with unhedged currency exposure, have been holding back both funds since the start of February’s rally.  Despite the idea of “cheap-money” behind the first TLTRO program, lending has remained anemic in Europe while the ECB’s policy of negative rates on large deposits and excess reserves led investors to rightly conclude that with profits being squeezed to the bone, the very survival of the European banking system was in doubt (not to mention that TLTRO I actually was supposed to be repaid in the immediate future.)  The fallout was intense with some of the Union’s largest and more strained banks feeling the pinch with Deutsche Bank dropping over 50% before stabilizing in February.

Fortunately TLTRO II is seen as being much more open-ended than its predecessor and allows for effectively rolling over any TLTRO I funds still outstanding and all EU banks need to do to cut the interest rates they pay into negative territory is to either slightly increase their lending or in the case of some banks, simply slow the rate of their loan contraction.  All in all, it was a pretty huge win for the banking sector (and an equally big acknowledgement that negative rates haven’t worked) that sent DB soaring up over 7% on the day while here at home one of the biggest winners was the iShares MSCI Europe Financials ETF (EUFN), up over 4.5% on Friday despite not having DB in its portfolio.  If you’re wondering why EUFN wasn’t on our short-list for biggest movers, the fund’s behavioral score experienced a slip dip at the start of the week while short interest and the put-call ratio remain relatively subdued.  U.S. financials were also feeling the love as Draghi’s intention to put a floor into the negative rate environment was seen as capping just how low the Euro can go and thus freeing Janet Yellen’s hand in raising rates here at home and giving American banks the reassurance that rates will likely rise again in the near future although the strong action in bank stocks wasn’t what put the market over the top.

What really helped domestic equities over the finish line on Friday was strong participation by healthcare stocks that have largely sat this rally out with the Healthcare Select Sector SPDR (XLV) coming in third-to-last with the fund up 7.9% compared to 15.29% for the Energy Sector Select SPDR (XLE).  It’s easy to understand why investors have been so adverse to the sector; the fallout in biotechnology and pharmaceutical names, especially Valeant Pharmaceuticals, is still fresh in our minds not to mention how much upside can be left after the sector lead the market higher for five straight years.  But Friday’s biggest mover in the healthcare sector was the iShares U.S. Medical Devices ETF (IHI) with a nearly 70% increase in its behavioral score driven in no small part by a nearly 10% allocation to Abbot Laboratories (ABT.) However, now that even healthcare stocks have started to rally, we can’t help but wonder if we’re near the end of this bull cycle for U.S. equities before we could return to the old highs.

It seems hard to believe, but at this time last month investors were demanding that the Fed abandon its plan to continue hiking rates in 2016 and instead were speculating on when they might need to announce another QE program, sending Treasuries spiraling to their 2011 lows while investors rekindled their love affair with gold.  Fast forward to the present and investors have begun returning to equity funds with nearly $4.6 billion flowing back after nine weeks of outflows according to Lipper.  But consider how far we’ve come in the last month; nearly 90% of S&P 500 components are back above their 50 day moving average with nearly 55% above their 200 day!  We know that sounds unimpressive but considering that a month ago less than 20% of stocks were above their 200 and just 10% above their 50, not to mention these are the same levels where stocks stalled out in October, there needs to be more than a sentiment shift to move this rally higher.

So while the consensus among forecasters is that Fed will hold its fire in March, it now seems the best that the Doves can hope for in the near future is language recognizing that the global economic environment remains weak and that the Fed will need to remain “data dependent” going forward.  But with earnings growth negative and subsequently both prices and multiples back to recent highs, we can’t help but wonder if the six week bull cycle we witnessed last October will repeat itself yet again?

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