Monday, September 17, 2018

GICS Changes and More Big Headlines

Monday, September 17, 2018 – The fickle nature of stock market sentiment was on full display this past week, as investors brushed off lingering, unresolved trade tensions to propel all 3 major indexes to weekly gains with the DJIA, S&P 500, and Nasdaq up 0.9%, 1.2%, and 1.4% respectively. Despite the looming imposition of 25% tariffs on an additional $200 billion of Chinese imports and a still wide gulf in trade renegotiations between the U.S. and its trading partners, apparent headway made with Canada and China helped buoy the major indexes for the week.

News that the US and China will be holding high level economic talks at the end of September and the subsequent boost in sentiment, belies the fact that are still a slew of key issues that need to be reconciled, of which neither the U.S. nor its trading partners have indicated any willingness to alter or moderate their conflicting positions. Among these outstanding disputes are the forced technology transfers, subsidization of state industries, and market restrictions imposed by the Chinese government and the future of dispute resolution panels in a revised NAFTA. Until these differences are bridged, the prospect for any meaningful reduction in global trade tensions is limited.

ETFG Quant Movers – This week's list of top ETFG Quant gainers is overwhelmingly populated with international focused funds, illustrating that despite current trade frictions, opportunities still exist for discerning investors. From 1-10, this week's top gainers were DGT, RNDM, IGT, IVLU, VEU, MFDX, IEUR, MLPG, FJP, and EUDG.

By the same token, as this week's list of top quant losers demonstrates, investors need to maintain a watchful eye when looking for opportunities in international markets as nearly half of this week's list have an international focus. The ETFs suffering the largest quant score declines were BRD, SDIV, SBIO, KBWD, PIN, VPU, SCJ, IPAY, MOM, and TTFS.

Looking Ahead - Arguably the biggest headline event in the upcoming week will be the introduction of the new GICS communications sector. In its largest reorganization ever, Wall Street's widely followed industry classification system will be reshuffling its consumer discretionary, telecommunications, and technology sectors to form a new communications sector on September 21st. Meant to reflect the evolution of the modern economy, the GICS overhaul will involve the migration of several bluechip names, including Facebook, Alphabet, AT&T, and Netflix, to this newfangled sector. Given the proliferation of index tracking funds and the market-leading position of many of these affected stocks, this taxonomy change will have critical implications for investors. All told, this change will reconfigure about 10% of the S&P 500's market cap and force passive managers who are benchmarked to these sectors to reallocate billions of dollars.

Although some preventive measures have been taken, such as State Street's launch of the Communication Services Select Sector SPDR Fund (XLC) in June and Vanguard's implementation of transition indexes and gradual fund rebalancings in May, some volatility will certainly be unleashed by this change. As this shift will prompt fund managers to offload or add major positions, investors in mutual funds will likely be hit with capital gains distributions. However, for ETFs investors, this move will reinforce one of the central benefits of the ETF structure - the in-kind creation/redemption mechanism, which will largely shield or limit capital gains.

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