Setting up for another Defensive Rally in 2015

While everyone else may be off enjoying some holiday cheer, the Yinzer Analyst is still hard at work trying to help give you the edge in 2015…mostly because it’s a great way to avoid watching 3 hours of NCIS with the family. But while investors may be patting themselves on the back for sticking around to enjoy the low volume Santa Claus rally and all new daily highs of .3% moves, I’m starting to wonder if a deeper shift in sector leadership is forming that could portend great changes in 2015. While the FOMC induced rally was a nice Christmas surprise for many managers who expected only coal in their stockings, some of the early December sector trends are beginning to reassert themselves and could be signaling a shift back to the lower volatility sectors.

First, in the interest of full disclosure, I do write for another site,, and the topic I’m going to discuss is one I’ve written about there previously. ETFG does offer free trial subscriptions although you should be able to access the blog without one and I’d encourage all of you to check it out although I will be discussing new material I haven’t shared there. With that out of the way, let’s start by looking at some of the more obvious developments over the last few days:

First, China A-shares are finally seeing some profit taking on investigations by Chinese authorities into market manipulation. There’s a joke in there somewhere, it’s just too obvious to make:


Energy stocks continue to show some signs of life, but have a ways to go before breaking the downtrend XLE has been stuck in for months:


Probably the most significant development this week is that profit taking has finally come to the healthcare sector as XLV has given up nearly all of the post-FOMC gains as a slate of negative announcements about products in the FDA pipeline meets year-end profit taking. Healthcare stocks had a rough first half of 2014 before coming back to life as investors sought out higher volatility wagers, but today’s 2.3% drop broke the six month uptrend pattern and could signify more selling pressure to come although some way-too-early bottom feeding might keep them in the green tomorrow. What’s going to be more interesting in 2015 is that healthcare stocks are the third largest % of the S&P 500 and have nearly twice the weighting of energy stocks. Will healthcare weakness weigh that heavily on the market?


So where are the profits taken from healthcare names being invested? There’s been a great deal of strong performance from the lower volatility sectors that help make up some of the more common low volatility “smart beta” ETF’s such as the iShares USA MSCI Minimum Volatility ETF (USMV). The phenomenon of low volume outperformance is nothing new and is one of the most demonstrated violations of the efficient market hypothesis so of course, someone slapped together an ETF to take advantage of this and all for a measly 15 bps a year. USMV has pulled in some SERIOUS cash this year and no surprise why, it’s up over 17.7% YTD compared to 14.9% for the S&P 500 Total Return and 11.7% for the average large blend mutual fund. But this success comes at a price; USMV and other low-beta ETF’s have been trading at record price multiples which have got the greats at the WSJ and FT wondering if you’re leaving yourself open to a low vol sell-off. Take a look at the chart below and you can see a major volume spike as investors took advantage of the FOMC rally to pick up USMV at a “slightly” lower price.


How did they generate such fantastic performance in 2014? Well yes, utilities were a part of that success but only a small part. For USMV, utilities make up about 8.5% of the allocation compared to the largest sector weighting with healthcare stocks at nearly 18% of the portfolio! Consumer Staples are #2 at 14% while 2014’s masters of “suckitude” energy stocks make up all of 5.7% of the allocation. So why do I go into this now? Well with healthcare stocks are trading at record levels and investors rightly concerned about profit taking, they’ve been casting their eyes at the other large components of USMV that haven’t participated nearly as much in 2014 and cutting out the middle man by investing in them directly to avoid the possibility to big losses after the multi-year run-up in healthcare stocks.

For USMV, the third largest sector holding is tech, with the largest weighting (6.6%) in companies on the services side such as Paychex, ADP and Visa as opposed to the largest positions in the Technology Select Sector SPDR Fund (XLK) like Apple or Google. I use the Vanguard IT VIPER as a better representation of low vol tech and you can see that as fears about the reality of rate hikes in 2014 set in this fall, VGT began making headway against the S&P 500 (using SPY) only to lose steam in mid-December when the “everyone in the pool” rally started on 12/16 and both VGT/XLK underperformed last week. Today it managed to get back above the uptrend line as reason returns after the initial joy starts to wear off (sort of like what happens after buying your wife a new car for Christmas.)


After tech stocks, the next largest USMV position is in the financial sector where high performing REIT’s are only around 3.4% of the allocation with insurance making up over 7.7% with the largest single holding being Chubb (CB) at over 1.3%. As you can see in the charts below; Financials (using XLF) and REIT’s (IYR) both lost steam versus the S&P 500 (REIT’s most noticeable in the late summer) as the sector leadership with the S&P began to change. Only with the breakdown of the energy sector in the fall do you see them begin to make ground with IYR breaking out of its momentum trade range while XLF begins to challenge it later in the year as the prospect for rate hikes becomes more realistic. In fact, financials underperformed last week not just on a pullback on low vol wagers but because the prospect for strong net interest margin growth seems more remote. One of the largest insurance sector ETF’s, the SPDR KBW Insurance Index (KIE), almost broke out of its momentum trading range versus SPY before the FOMC rally left low vol in the dust.




In fact, if you look at this chart of utilities compared to the S&P 500 (xlu:spy) or USMV to SPY, you can see that a good portion of the mid-October rally was the contribution from low vol stocks pulling the S&P 500 higher almost against its own will given the weakness in energy stocks and the short-lived weakness against the high vol sectors last week is easing before year end.


Again we have to wonder, will 2015 see another record year on a defensive rally?

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