Tuesday, June 27, 2017

Yellow Flags ahead as Technology and Health Care Surge

Tuesday, June 27, 2017 - Stock indexes were anemic last week despite strong showings by Technology, Healthcare and Biotech Stocks. Headlines included MSCI’s decision to add China A Shares to their Emerging Markets Benchmarks – a real win for China which lobbied hard for its inclusion and the Italian Government’s taxpayer funded bailout of 2 regional banks which give reason for European investors to breathe a sigh of relief and should allow European shares, particularly Financials, to resume their upward march. US Investors journeying overseas to Europe could find the wind to their backs from both increasing stock prices and a weakening dollar should interest rates continue to stagnate or decline.

Of course the big news in the US was the revelation of the long awaited Republican Senate’s Health Bill.  While addressing some of the more controversial particulars of the Affordable Care Act, it also included a hefty dose of Supply Side Tax Cuts to certain high income earners as well as select industries. No doubt this plays into the first act of any significant fiscal stimulus effort i.e., reflationary effort. Investors should carefully watch for indications of passage of this bill as lack of passage would indicate a stalling of the Trump pro-growth agenda due to political deadlock. This would be a disappointment for investors.

US Benchmarks were mixed with the S&P 500 closing up .21% for the week to 2,438.3 and the Russell 2000 rising .57% to 1,414.78. The tech heavy Nasdaq Composite rose a hefty 1.84% to 6,265.25 while the S&P Technology Index rose 2.3% and the Healthcare Index rose 3.7%. Biotech Stocks continued their move up as well - the latter two benefiting from the Senate’s Health Care Proposal. Internet stocks continued to roll along with the DJ Internet Composite closing up 2.95% as investors reflect on the consequences of FANG and companies expanding their footprint into traditional businesses. Indeed with just 5 days to end the first half of the year, US investors have cause to celebrate with the S&P 500 likely to close near +9% for the period all the while enjoying unusually low volatility and a noticeable lack of any minor retracements. JP Morgan’s Marko Kolanovic noted on June 13th that in the past 20 years, the VIX index has closed lower than 10 on a total of 11 days; seven of those days were in the past month.  Given leveraged asset prices and a less accommodating global monetary environment, volatility is sure to return. Hence, caution is the call.

The yellow flags we see on the second half horizon are a flattening yield curve – a harbinger of low growth or worse and declining commodity prices led by oil and other mining commodities. While declining oil prices (US Crude down -2.68% to $43.13 per barrel) dragged down Energy Stocks by -2.9% for the week, more troubling is the continued yield decline of the 10 Year Treasury by -.11% to 2.155% decreasing the slope of the yield curve even more. Continued interest rate declines indicate that bond investors see slow growth and possibly more disinflation due to disruptive technologies and low aggregate demand due to low wage growth on the employment side. This had the effect of dragging down Financials by -1.7% whose fortunes are tied to higher interest rates. While we are told that oil is suffering a temporary oversupply rather than decline in demand, we cannot help but wonder if the increased use of natural gas, wind and solar power are chipping away at demand not unlike Coal, despite the White House attempts to talk up the black rock. Could the long observed correlation that strong oil prices indicate strong economic activity be weakening? One bright note is that household formation demographics are fueling a recovery in housing prices which will have the affect of offsetting any pinch from potential stock market declines.

Investors wanting to bet on the passage of the Senate’s Health proposal should consider loading up on Health Care and Biotechs – astute traders can use the double or triple levered versions. Technology continues to be a good bet as well.

Nevertheless, we continue to believe that the animal spirits unleashed by the excitement of the Trump Presidency are alive and we would not leave the party yet. The underlying expectations for earnings increases to drive stock prices are being fuelled by demographics in the housing sector and the obvious need to boost infrastructure spending.

We continue to favor the Reflation trade and the proposed tax reform and relaxed financial regulations could benefit sectors like select Financials, Utilities, Technology, Healthcare Insurers, Hospitals and Pharma companies – although significant risks abound in the healthcare sector.

Indeed our ETFG Quant Score list shows 7 of the top scoring funds in our Top 25 Quant Rankings fall into our above narrative with a score of 71 or better. They include QQQE and BBH for US BioTech and Tech plays, PGI, FXI, FNI, AADR and EWY for China and Asian exposure. Given the value play in Energy Sector, we would look at the Select List to find some good ranking there. See last week’s Perspective.

Looking at our Quant Movers Weekly Top % Gainers, we find 5 of the top movers are Infrastructure themes:  AMZA, MLPX, YMLI, NFRA and TPYP - VEU, TUR, VWO, and ECH come up for International Exposure.

We suggest looking over the Quant Movers Daily % Movers to zero in on attractive plays and sudden changes in our ratings outlook.

Thank you for reading ETF Global Perspectives.

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