Monday, May 16, 2016

Is Boring the New Sexy?

It was another 2016 first for equity markets as another weak Friday showing pushed the top exchanges lower for a third consecutive week that has many wondering if “sell-in-May” is on this year.  The bulls are quick to point out that the S&P 500 was only off .5% for the week and is still within spitting distance of recent highs (not to mention that earnings have nowhere to go but up from here right?).  Yet even the most ardent believer will experience a moment of doubt when they consider that Friday’s loss was widespread and tipped the S&P back below its 50 day moving average while long-term Treasury yields head back to their early April lows.  Normally, this is the part in the conversation when the typical prognosticator would encourage investors to look for safety and income in Consumer Staples but as our ETFG Quant report shows, this “safe bet” could be anything but.

The genesis of this week’s piece was the appearance of the PowerShares High Yield Equity Dividend Achievers Portfolio (PEY) in our list of top behavioral movers as its score rose almost 77% last week even though the fund underperformed the broader market on Friday.  In fact, most of the big gain came on Friday when the fund rose 55% despite that relatively weak showing and that’s what has us wondering how much longer the run-up in defensive names can go.  Last week we talked about how the high-flying “defensive” sectors were dominating our list of behavioral top scorers and that eventually they may become the biggest losers when sentiment changes or fundamentals again become important, but what we didn’t discuss was how they get on that list in the first place.  There’s no denying that funds with an income or low volatility focus are expensive right now; try re-orienting our fund universe based on their fundamental scores and you’ll see nearly every Consumer Staples, Low Volatility and Dividend Income fund we track is trading close to their all-time high multiples but what happens when investors begin looking for a better way to make money than collecting dividends?

Remember that our behavioral scores are a combination of price momentum and sentiment scores derived from factors like high short interest and implied volatility and as you can see from the ETFG Quant Report, it’s those sentiment scores that are keeping Consumer Staples and Low Volatility funds at the top of our behavioral lists and specifically short interest.  This makes sense as funds like the Consumer Staples Select SPDR (XLP) or the PowerShares S&P 500 Low Volatility Portfolio (SPLV) which had a great second half of 2015 had begun to see their momentum wane in February as investors decided that a bear market wasn’t imminent and instead looked for easy capital gains in beaten up industrials and energy stocks while trading at peak prices made them a hard sell for clients looking safety who instead turned to utilities.  The rising tide in equities helped lift these funds higher although they lagged the broader markets advance while weaker earnings made them even more vulnerable to short sellers who have been gearing up for the next pullback.  Try reordering the list based on short-interest and you’ll see that SPLV, XLP and now tiny PEY have their short-interest trading close to their highest levels while there’s been a clear drop off between their short-term and longer-term momentum scores.

And which momentum scores are through the roof right now?  Utilities funds dominate that list with the Fidelity MSCI Utilities Index ETF (FUTY) at #7 followed by the Utilities Sector Select SPDR at #9 and the Guggenheim S&P 500 Equal Weight Utilities ETF (RYU) at #10 respectively and for many, utilities are a slam dunk despite their weak earnings growth and dim prospects.  One major factor behind Consumer Staples recent fall from grace is that the financial media has become obsessed with the idea behind “disruption” or that when the economic outlook is so dim, it’s time to pay up for “growth” prospects and as an example, witness the spread between traditional retailer Wal-Mart, down over 4% last week while on-line competitor Amazon was up 5.3%.  XLP is dominated by “traditional” names facing issues whether it’s sugar drinks, big box stores or just good old-fashioned cigarettes, the space has none of the sexy names that seem to be the only ones capable of capturing investor attention.  And while no one will call utilities “sexy”, they do operate in heavily regulated markets and don’t have to worry about new competitors disrupting their business model.  In a volatile market like this one, that might be the sexiest thing going right now.

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