Leaning Into the Wind

If there’s one thing that’s clear (or maybe not) from last Friday’s disappointing (or secretly positive) jobs Report is that America is back (or doomed!)  Confused?  Well then, you’re in good company as money managers appear evenly split into two opposing camps; the first wonders whether April’s Employment report signified that the economy is close to full employment that further big gains are unlikely indicating that rates should begin to rise while the second believes the dip in participation and flat lining earnings growth indicates that it’s too soon for the Fed to take off the training wheels.  After sorting for clues to which side is strong in our ETFG Quant Movers and Top Behavioral Funds Reports, the one thing that actually is clear to us is that someone is setting themselves up for serious disappointment.

It’s easy to lose sight of the bigger picture when you’re stuck in the minutiae of earnings seasons or debating what the Fed should or shouldn’t do, but while most investors were busy reading headlines they missed out on a major sector rotation that’s been underway for several weeks.  Friday’s late rally may have helped stocks end Friday on a positive note but the S&P 500 has now closed down for two consecutive weeks, something that hasn’t happened since the rally started in February, as a strong showing by materials and tech stocks couldn’t undo the damage inflicted by healthcare stocks that still can’t find their footing.  But while healthcare stocks and high yield bond funds are licking their wounds, gold mining funds were off at the bar celebrating as the Market Vectors Gold Miners Fund (GDX) rose over 3.9% on the day while it’s junior miners counterpart, GDXJ, was up almost 5.5%.  Gold bugs will tell you that the miners have nowhere to go but up from here and while that may prove true, that they desperately needed that win to prevent an embarrassing momentum reversal.

While we’ve been talking about Apple and Tesla, defensive favorites like utilities, consumer staples but especially the gold miners have been quietly taking over the top spots in our ETFG Behavioral Top Scorers Report as the great 2016 rally looks increasingly overdone.  The S&P 500 might be off just 1.65% in the last two weeks but there’s been a substantial decline in the percentage of stocks trading above their 50 day moving average as investors decide to sell in May and go away or just rotate back into old favorites which is one reason why the Utilities and Consumer Staples Select Sector SPDR Funds (XLU and XLP) are up 3.1% and 2.5% respectively while GDX is up an astounding 11.2%!  In fact, visitors to our ETFG Behavioral Top 50 will note that 14 of the funds on that list are in one of those three categories with XLU and XLP holding down the second and third spots respectively (behind a junior gold miner of course) with even more funds focused on low volatility or high dividend payers helping further boost the presence of defensive names.  Of course, the only problem with being on top of the list is that it never lasts.

Now we’re not talking about karma or the wheel of fortune, just that defensive funds have had the wind at their back and are now richly priced and investors can be a fickle lot, never more so than in late-stage bull markets.  Consider that all three of those categories had a spectacular start to 2016 after the Fed’s first rate hike only to see their momentum slow when the broader market began to find its footing in February when investors realized that the end was not indeed nigh.  By then the “defensives” had pushed their way into overbought territory and needed time to cool off with XLU and XLP both experiencing drawdowns that were saved by bouncing of the fifty day moving average but neither fund has gotten back to their 2016 high.

It’s a different story for GDX who kissed the fifty-day goodbye in February and hasn’t looked back although its most recent move higher that began in April is far less steep than it was at the start of the year.  And while they may sit at the top of the Behavioral Charts, the “defensives” performance was generally spotty last week with the exception of XLP which logged a series of steady advances while XLU and GDX have been experiencing more volatility.  In fact, before Friday’s rally GDX was down almost 6.4% while a big rally after Wednesday’s ADP report helped XLU close higher than the market for the week although the spread between the two was much narrower than the prior week’s.

Even Friday’s rally that helped the miners narrow the gap was a bit of a headscratcher as the more bullish side of the market decided to take a more positive view of the big “miss” as a sign of potentially reaching “full employment” and a signal that traders are underestimating the possibility of further rate hikes in 2016.  Those comments gave a boost to the PowerShares DB US Dollar Index Bullish Fund (UUP) which despite breaking a prior support level several weeks ago has been slowing its descent and trying to find a base.  But those looking for an equity sector that could stand to benefit the most from shifting expectations should take another look at financials and bank stocks whose behavioral scores have been plummeting towards rock bottom as investors gave up any hope for another rate hike in 2016.

The reigning sector heavyweight remains the Financial Select Sector SPDR Fund (XLF) which not only made our list of biggest behavioral score losers for last week but also has the notoriety of having one of the lowest ranked behavioral scores of any product in our database.  Not far behind on that list are two bank stock funds we’ve often discussed in these pages, the SPDR S&P Bank ETF (KBE) and Regional Bank ETF (KRE) both of which, along with XLF, saw a .4% move on Friday as investors cautiously eyed up a sector they had left for dead just weeks before.  Only time will tell which side will be proven right, but for now it certainly does seem those adventurous bullish investors are leaning into the wind.

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