Tag Archives: seeking-alpha

Dollar Sensitivity: The New Style And Size Debate

By Jeremy Schwartz When making investment decisions, many are familiar with making allocation decisions between large and small caps or between growth and value stocks. These decisions to over- or under-weight different segments of the market are what drive relative returns, and depending on your allocation mix, the returns can be quite different. Recently, as a result of the divergence in central bank policies, investors have also had to take views on currency risk, with clear winners and losers. Increasingly, we have seen investors shift away from currency risk in the developed international markets-specifically Europe and Japan-and focus just on the equities through currency-hedged indexes. But what about the currency impact on domestic equities? Currency Factor in U.S. Equities Currency moves are not just important to foreign markets. In the U.S., we have also seen U.S. dollar strength impact stocks that are exposed to sales in foreign markets. It is widely known that a significant percentage of the revenues of U.S. companies in the S&P 500 Index comes from abroad. If the U.S. dollar continues to strengthen, this is likely to provide continued headwind for the companies with meaningful revenue from and business exposure in foreign markets. By contrast, if the U.S. dollar reverses, these firms should benefit. WisdomTree designed two new U.S. equity factor Indexes to help position investors according to their view of the U.S. dollar’s direction. WisdomTree Strong Dollar U.S. Equity Index (WTUSSD) – includes only firms that derive more than 80% of their revenues from the United States. These companies tend to be less impacted by a strong-dollar environment-they aren’t focused on selling their goods and services abroad, and their import costs decrease with the dollar’s rising purchasing power. The Index also tilts weight more heavily toward stocks whose returns have a higher correlation to the returns of the U.S. dollar. WisdomTree Weak Dollar U.S. Equity Index (WTUSWD) – includes only firms that derive at least 40% of their revenues from exports. These firms tend to be more impacted by a strong-dollar environment, as they are focused on selling their goods and services abroad. Similarly, during a weak-dollar period, we’d expect these firms to become more competitive in selling their goods abroad. The Index also tilts weight to stocks whose returns are more negatively correlated (or have a lower correlation) to the returns of the U.S. dollar. Below we compare the since-inception performance of the WisdomTree Dollar Indexes, as well as popular size and style indexes, to get a sense of divergence between factors. Index Performance (click to enlarge) For definitions of indexes in the chart, visit our glossary . Dollar Indexes Divergence: we find the 3.98% divergence between WTUSSD and WTUSWD interesting, especially considering the short-term performance period. Despite that and the fact that analyzing just performance is not a robust statistical analysis, it seems there have been clear winners and losers, with WTUSSD coming out ahead. It is also interesting that the discrepancy is larger than the 2.92% difference between the S&P 500 Growth and S&P 500 Value, leading us to believe that the WisdomTree Dollar Indexes are offering differentiated exposures. Performance Differences between Size Indexes: have been the smallest (at 0.23%) of the indexes shown above. The difference is interesting to us because we often hear that small caps should be impacted less by a strengthening dollar because their revenues are typically more domestically focused. We estimate the weighted average revenue from outside the U.S. at 19% and 38% for the S&P Small Cap 600 and the S&P 500 indexes, respectively. Again, the period is short and there could be other factors driving the returns, but it is something we will continue to monitor. Can the Separation Continue? One of the most important macroeconomic forces impacting the markets have been currency changes motivated by diverging monetary policies. If you believe the U.S. dollar will continue to strengthen over the coming years, as is WisdomTree’s baseline view, this could provide the backdrop for continued divergence among U.S. equities. The degree or speed of the divergence is hard to predict, but we think it will be important to continue monitoring the performance differences for this new factor and look to provide commentary around any continued divergence. Important Risks Related to this Article Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Jeremy Schwartz, Director of Research As WisdomTree’s Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel’s head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”

Time For These Top-Rated Cyclical ETFs?

The markets have been lukewarm lately as participants are holding their breath to study every bit of the Fed-related news. No doubt, signs of a snap-back are pretty much there in the U.S. economy, but the recoil is not flawless and the global market volatility ticked up to a delirious level, thanks mainly to the China issues. Also, previous remarks by the Fed have only added to the uncertainty as the central bank sought more improvement in the labor market and inflation backdrop. The U.S. economy underwent an upward GDP revision for the second quarter of 2015, from 2.3% reported earlier to 3.7% upgraded later on strong domestic demand. If this was not enough, the unemployment rate dropped to 5.1% in August, the lowest since April 2008. While this more-than-seven-year low unemployment rate should bolster the case for an imminent policy tightening, a still-muted inflation backdrop backed by an oil price slump, lackluster wage gains, a missed job expectation in August and a feeble overseas market are blurring the optimism. All these have put this week’s Fed meeting in the high-alert zone. Cyclicality of Sectors Whatever the case, no one can deny the growth in the American economy given the solid housing data, improved confidence among citizens and decent recovery (if not brisk) in several cyclical sectors like retail. Added to this, historically cyclical sectors outperform the defensive ones when the rates normalize. These areas often slump when the economy is tumbling, but are among the biggest winners when the economic environment turns favorable. Among the cyclical ones, as per Fidelity, sectors like consumer discretionary and financials and economically sensitive sectors like industrials and information technology tend to do better in the early cycle of the an economic recovery. Fidelity defines an early cycle phase when economic activity revives, credit starts to grow, policy is still accommodative and sales and profits improve. With many of these conditions present in the U.S. economy, we can conclusively say that the coming months will be fairly dominated by the cyclical sectors. If the Fed at all hikes rates this month, it should not be more than just 25 bps; otherwise, investors might see the timeline shifting to the end of the year. In either of the case, a few cyclical sectors and the related ETFs are expected to perform impressively especially given the expected earnings growth trend. For these investors, we highlight three ETF picks below that have heavy exposure to the cyclical industries: Market Vectors Retail ETF (NYSEARCA: RTH ) The retail sector can best reflect the lift in an economy as it revolves around discretionary purchases. Though the August Retail Sales report was mixed, with the ‘headline’ growth rate falling short of estimates, its internals exhibited improved momentum and the prior-month’s numbers were revised higher. The sector is expected to post earnings growth of 0.4% and 6.4% in Q3 and Q4 of this year, respectively, both better than consumer discretionary sectors. Its sales expectation is also steady at 3.5% for Q3 and 7.1% for Q4, again better than consumer discretionary. More jobs and cheaper fuel should help the sector to grow. This retail fund has a Zacks ETF Rank #1 (Strong Buy) with a Medium risk outlook. The fund has added over 5.7% so far this year. PowerShares DWA Technology Momentum ETF (NYSEARCA: PTF ) The technology sector saw certain setbacks this year as the stocks were crushed during the market correction in August. The sector went into a tailspin on acute sell-offs in tech biggies like Apple (NASDAQ: AAPL ), Goggle (NASDAQ: GOOG ) (NASDAQ: GOOGL ), Microsoft (NASDAQ: MSFT ) and IBM (NYSE: IBM ). However, the nightmare should soon be over, as the sector is expected to register a 2.8% earnings growth in Q3 and an 8.8% jump in revenues. This technology ETF currently has a Zacks Rank #2 (Buy) and has advanced 5.1% in the year-to-date frame (as of September 15, 2015). PowerShares KBW Regional Banking Portfolio (NYSEARCA: KBWR ) This regional banking sector has benefited greatly from approaching Fed policy normalization. The space boasts solid Zacks Ranks. In any case, U.S. banks reported solid earnings this season with 11.6% growth in earnings on 0.6% decline in revenues. Banks recorded 66.7% beat on earnings on 60% top-line beat. Overall the financial sector is expected to deliver stellar earnings growth of 8.6% and 15.1% in Q3 and Q4, respectively. Very few sectors are able to attain this envious growth rate, especially given the even-increasing global growth. However, there will be no expansion in revenues. Regional banking ETF ( KBWR ) is up 3.8% so far this year and has a Zacks ETF Rank #2 with a High risk outlook. Original post .

A Cure May Be In Store For The SPDR S&P 500 Trust ETF

When I warned about market correction in mid-August, I also discussed what factors would eventually cure what ails us. One of those factors is presenting itself Thursday, as the Federal Reserve offers clarity on an uncertainty weighing on investors’ minds and weighing down stocks. The probability of Fed inaction on interest rates or the possibility of a minor action with the removal of concern about October should serve stocks immediately. I expect such a scenario should provide immediate & significant upside to the SPDR S&P 500 Trust ETF, returning it toward its highs above $210 and higher as longer term factors. Risk to this thesis could come from a Fed rate action of 0.25% or if the Fed does not clear away concern about a potential action in October. When I authored my warnings about market correction in early to mid-August, I also indicated what the cure for stocks would eventually be. One of those factors appears to be about ready to help out, and that is clarification from the Fed. No matter what happens Thursday afternoon, the Federal Open Market Committee (FOMC) will provide some clarity to investors. Stocks should benefit from the removal of some uncertainty, and I see immediate upside of 2.5% to 5.0% probable for the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) post the Fed meeting. But any gains and the length of duration of upward direction will depend on the specifics of what the Fed does and says. The longer term for stocks and the SPY will continue to depend on the U.S. economy, energy sector issues, emerging market implications, seasonal capital flow factors and the Fed path and accuracy moving forward. 1-Year Chart of SPY at Seeking Alpha In my early to mid-August warnings of imminent market correction (see several links within the summary piece), I suggested the eventual cure for stocks would require a cocktail of medicines. I discussed the implications of seasonal capital flows and that the passing of time toward November 1st and a more welcoming capital flow environment would serve stocks then. I also suggested the U.S. economy mattered far more than the Federal Reserve, and that we would need to see health in the economy to gain traction. That means that the U.S. energy sector must heal or at least not meaningfully infect the rest of the economy. It also means that China only stumbles and does not fall, and that growth recovers in that important sector of the global economy. Finally, I said we needed Fed clarity, and that uncertainty about the Fed’s path was not serving stocks. Thursday, we will receive some clarity on the Fed’s path. Most likely, the Fed will succumb to market pressures and refrain from raising rates at this meeting. However, I’m not sure that is the best case scenario. Rather, I believe a minor rate hike of less than a quarter of a percentage point would serve to satisfy expectations that Fed action is happening this year while also easing concern that the Fed could act prematurely. If the Fed makes a minor move and indicates it is not likely to act in October, pushing expectations for the next hike to possibly December or March, it will serve stocks well. It is also likely to reiterate its data dependence and to note risks to the U.S. economy including China and emerging markets, the U.S. energy sector, and the strength of the dollar. But I also anticipate the Fed will note the strength of U.S. labor and the lack of inflation, which are positives. I suggest such an outcome would be just what the doctor ordered for the stock market. The result, in my view, would be a surge in stocks and a marching of the SPDR S&P 500 Trust ETF back towards previous highs certainly above $205, and probably to $210 or higher without much disturbance. Much depends on the specifics of the very complex data set we will get from the Fed. A risk lies in the possibility that the Fed raises rates by a quarter of a point. Such a scenario, I believe, would send a shock through the market and spur a selloff back to correction lows. That is not perfectly clear, given that investors would like to see the Fed finally get started at some point. However, I expect that given the latest poor indications from China and emerging markets, the Fed will refrain from further disturbing the global economy and the U.S. economy as a result. Despite the likelihood of inaction, in my opinion, the FOMC vote could be closer than in previous meetings. Investors will need to have some indication that October is not a threat as well, or this period of volatility will simply extend to the next Fed meeting. So if the Fed does not act, but leaves the possibility of an October action on the table for investors to worry and debate about, stocks could see their upside limited or completely erased. Over the long-term, what matters far more than the Fed are the health of the U.S. economy and the health of sectors of the global economy that threaten the U.S. economy. That means, not only must U.S. data continue to reflect progress, especially in the labor market and GDP data, but weakness in the U.S. energy sector and manufacturing (relative to it) must dissipate. Also, China must stabilize rather than deteriorate; if this occurs, expect global stocks to rally significantly. Finally, as September and October pass, significant capital flow pressure from institutions ending their fiscal years will dissipate and likely offer support to stocks as the institutions look forward with many securities trading at relative value. We are in a complex period now, where the market is supersensitive to news flow. It is the worst possible time for the Fed to be contemplating action, but it is our situation. Long-term investors should be patient now, but remain focused on the matters discussed herein. I cover the market closely, and invite relative interests in the SPY security and the market to follow my column here at Seeking Alpha . Disclosure: I am/we are long SPY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.