Small-Caps and the Yield Curve

After under-performing the S&P 500 for the better part of 2014, the Russell 2000 began to show some signs of life in the third quarter. Following a false breakdown of a key support level, small-cap stocks have slowly begun to outperform large-cap stocks, making higher-lows on relative basis.

The Russell ended the year on a high note, breaking out above the strong 1,208 resistance level; but that was short lived as prices have recently come down sharply, breaking below the 50-day moving average.  

As we look at the sustainability of the Russell’s out-performance, it is important to look at the steepness (or in this case, flatness) of the yield curve (30-year minus 2-year yield). Looking back historically, any sustained out-performance of small-cap stocks was accompanied by a steepening yield curve. The continued flattening of the yield curve signals that investors’ inflation expectations are falling. Small-cap companies tend to favor inflationary environments as they have more leeway to raise prices relative to their larger-cap counterparts.  

The spread between the 30 & 2-year yields is diverging to multi-year lows, not confirming the relative strength we have been seeing in the Russell. As we roll into 2015, investors should monitor this relationship for clues to whether the strength in small-caps is short-lived or perhaps something more substantial. 

Tom PsarofagisComment
Discretionary/Staples Ratio

One quick way to analyze investors’ appetite for risk is to look at the ratio of Consumer Discretionary (XLY) vs Consumer Staples (XLP) stocks. The idea here is when investors are willing to take on more risk, they favor XLY and thus, the ratio line will move upward.

Below is a chart of the S&P 500 compared to the XLY: XLP ratio

As you can see, the ratio did a pretty good job of foreshadowing major market moves. As the market continues to rally off its 2009 bottom, the ratio had also been making higher-highs, pretty much in tandem. It’s recently where we are starting to see a divergence where the market grinds higher and the ratio fails to make higher highs. The same divergence was occurring before the market collapsed in 2008.

Although in isolation, this indicator doesn’t necessarily constitute a “sell signal”, but has been a fairly good early warning of risk aversion and analyzing the sustainability of the market’s advance.  

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Financially Savvy

The biggest players in the financial sector are set to report earnings this week (some already have), and as Mr. Market tries to get it’s footing, the financial sector has been outperforming.

·      Wells Fargo, JP Morgan, Citigroup - Reported Tuesday

·      Bank of America, American Express- Wednesday            

·      Goldman Sachs – Thursday

·      Morgan Stanley- Friday

Financials were lagging throughout the spring this year, but have really started to come back aggressively since mid-August.

Luckily for ETF investors, there are several tools aimed at different areas of the financial sector. In the table below, there are 4 options I highlighted.

XLF, the largest and most popular product, is the best performer as of Tuesdays close, up 4% on the year. XLF is very top heavy, with Berkshire Hathaway and Wells Fargo accounting for 17% alone.  That may sound scary, but that allocation has paid off YTD as both companies are posting gains of 15.8% and 10%, respectively.

RYF is an equal-weight product by Guggenheim, spread evenly among 85 holdings. RYF is trading similarly to XLF, up 3.6% YTD. 26% of RYFs holdings are in the REIT sector. The Dow Jones REIT Index is up 14% on the year, helping boost performance.

Smart Beta has been a hot topic in the ETF space this year, and there are 2 factor driven Financial ETFs. Year-to-date, both the PowerShares and First Trust “smart” ETFs are negative on the year, -4.5% and -1.4%, respectively.  Stock selection matters, because PFI, also heavy in REITS,  is lagging to keep up. In the case of the FXO, nearly 40% of the fund is invested in insurance names, a group that’s struggling on the year.

It is imperative that ETF investors look past just the name of a product and dive a little deeper into its allocations…Not all ETFs are created equal 

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Trash Talk

Investors recently have gotten an earful about small-cap underperformance, gold, Europe, oil and the list can go on and on. I wanted to take a second and focus on a less covered area: Environmental Services (aka the guys who keep our streets clean). I was recently looking at the chart of Waste Management, the largest piece of this $40 billion industry. I am no garbage expert by any stretch, but I remember WM CEO, David Steiner on CNBC recently mention that “tracking trash” can provide a glimpse into economic growth. With the increased usage of e-commerce and the holiday season quickly approaching, someone needs to recycle these Amazon Prime boxes. Given the recent sell-off in the broader markets, WM has held up very well, really adding some distance ahead of the S&P since the late summer.

Market Vectors has focused on this sector since 2006, when they launched EVX, the Environmental Services ETF. The ETF has amassed only $15.9 million in assets spread among 28 holdings. EVX is extremely top heavy as the top 5 holdings account for nearly 45% of the fund.

EVX recently hit an all-time high in July before turning sour, sitting on a 2% loss for the year. September was quite the busy month as it made lower-highs and broke back below the 50-day moving average, 200-day moving average, and the important support level of $65. There could be further weakness ahead as the next support level is roughly the $62 level.

Although EVX is down collectively in 2014, individual names have stacked up fairly well against the S&P’s 5% YTD gain:   WM (+7%), SRCL (+.2%), RSG (16%), VE (12%), ECOL (22%)

Weather or not garbage is any “indicator” of economic growth; EVX might be a ticker to add to your watch list. 

Tom PsarofagisComment
How Do You Euro?

US small-caps have hogged all the spotlight recently, but it is important to take at look at what’s been happening in Europe. If you remember, ECB Chief Mario Draghi took aggressive measures in early September to boost the Eurozone economy; including cutting interest rates and kick starting an asset-backed security purchase program. Super Mario has vowed to remain accommodative for a long as it takes, but European equities continue to slide lower.

Referring to the Euro/S&P 500 relative chart, European equities have underperformed their US counterparts for quite some time. Things got really ugly in June of 2014, hitting relative multi-year lows recently. 

There are several broad European focused ETFs (highlighted below). Although FEZ and EZU do not have any exposure to the United Kingdom, all 4 products track very closely.

If we take a closer look at the largest product, the Vanguard Europe ETF, we can see the ETF is breaking down technically, especially after seeing a “death cross” earlier in the month. You can also see a breakdown in the individual country components as well.

Regardless of what Super Mario has up his sleeve, the Euro markets will need to be watched closely. 

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All Aboard

The Dow Jones Railroad Index has had quite the busy summer. After correcting sharply in July, the index is higher by nearly 10% since mid-August. Despite the sell-off in recent days, the index is sitting on a solid 20% gain on the year. Unfortunately, there is no pure play ETF product for this sector, but there is a way investors can get some decent exposure to the rails.

·      iShares Transportation ETF (IYT): This ETF currently has a 25% allocation to railroads, with 4 railroad names in its top 10 holdings.

·      SPDR Transportation ETF (XTN): This product has a slightly lower allocation to railroads, at 13%. Similarly, 4 railroad names are in the top 10, with Kansas City Southern as the funds top holding (2.6% weight).

Below is a chart of IYT, the larger of the 2 products. IYT has broken down below the $152.30 support level in recent trading. IYT needs to hold the $150.50 level, with coincides with the 50-day moving average.

Individual rail names such as Union Pacific, Norfolk Southern, and CSX all hit multi-year highs in the last few days, but have given back some of those gains in the recent market weakness. Kansas City Southern is the laggard of the group, trading slightly down on the year.  

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Getting Chile

The chart of the world’s largest copper producer has been a sight for sore eyes. Thanks to dismal housing data out of China (worlds largest copper importer) and the US Dollar ripping to the upside, the future looks bleak for the industrial metal. The weakness in copper prices can been seen reflected through the iShares MSCI Chile ETF (ECH).

3-year: ECH vs. Copper Prices

3-year: ECH Relative to EEM (Black) and Latin America (Green)

Chile continues to be an under-performer both globally and in Latin American, not seemingly able to find a bottom.

YTD: ECH

The ETF is down roughly 8.5% in 2014, and although off its lows for the year, broke a trend line in the summer months. ECH is sitting on support at these levels after hitting strong resistance in early September. Things can turn ugly real quick if it fails to hold.  

The product was launched in 2007 and has amassed roughly $350 million in assets. The fund currently has 39 holdings, mostly in utilities and financials. The top 10 holdings account for a 62%, so keep in mind it is a top-heavy product. 

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Good Harvest?

The explosive rally in commodities has definitely turned some heads this year. Knee-jerking moves in coffee and natural gas now have investors looking...dare I say it, elsewhere besides the S&P 500. I wanted to look more closely at the move in agricultural commodities, more specifically the Powershares DB Agriculture Fund (DBA). This ETF does not hold actual companies, but rather futures contracts in various commodities. DBA's largest exposure is to Coffee (+61% YTD), Sugar (+6%), Corn (+6%), Live Cattle, and Soybeans (+6%) among others. After a poor showing in 2013, DBA is currently posting a 12% gain in 2014.

Looking at the chart below, the move this year has been near parabolic. DBA blew through its 50 and 200-day averages, along with any significant resistance levels. The RSI is dangerously overbought, so I would expect DBA to cool-off a bit. There was a very similar move in the middle of 2012 (see weekly chart below), where DBA skyrocketed, consolidated for several months, then bled it all away over the next few years. Time will only tell if this spike will show similar price action.  

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Shifting over to a longer term weekly chart, this recent spike is bumping up against a declining resistance line from 2011. Should DBA have the momentum to break up and out of the $28 level, things could get very interesting, as $30 is the next significant resistance level. Regardless, the move in DBA has been really exciting and is worth watching closely. 

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Come Fly With Me

While the S&P 500 gets off to a rocky start this year, airline stocks are flying first class. Delta and Southwest are among the S&P's best performers and the NYSE Airline Index is up 2% YTD.   Unfortunately, there are currently no pure-play Airline ETFs (Guggenheim and Direxion tried and both products were liquidated), but there are other alternatives. One way, of course is to play individual names like JetBlue (+6.3% YTD), United (+22%), Delta (+11.5%), and Southwest (+12.2%). There are also 2 products with airline exposure XTN (-0.1%) and IYT (-1.0%). 

Chart shows comparison of the Airline Index, IYT, and XTN. Of course the performance will differ because the ETFs are not pure airlines, but they are rather correlated and move in the same general direction.  XTN has a larger allocation to airlines, which has helped propel it past IYT     (2013 Performance: XTN +51% and IYT +40%)

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IYT currently has $765 million in assets and an 18% allocation to the airline sector. Alaska Air is the only airline in its top 10 holdings with a 6.8% weight. IYT hit a 52-week high on 1/23/14 and is overall, outperforming the S&P 500. After a sharp sell-off, IYT is toggling back and forth between its 50-day moving average. If this level can hold, it may try to make an attempt back up to $135 to fill the sell-off gap. 

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XTN is a much smaller product with only $96 million in assets. The fund has a 26% allocation to airlines and currently has 6 airlines in its top 10 holdings. American Airlines is the funds largest holding with a 3.2% allocation. The chart of XTN does not look much different from IYT, and this is also attempting to hold its 50-day moving average after a sharp sell-off.

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SPDR S&P Metals and Mining ETF (XME)

Gold (and Gold Miners) continue to be a hot topic after the dismal 2013 returns. GDX, the most popular way to play gold miners, is looking a bit brighter in 2014 with an 8% YTD gain. The story for XME, isn't quite as shiny. Although XME does currently have an 11% allocation to gold miners, thats not enough to keep it above water as its sitting with a 6.9% YTD loss. XME can thank the coal and steel sectors for its lackluster performance, as both sectors have been atrocious to start the year. Using ETFs as a gauge, coal (KOL) is down 9% YTD and steel (SLX) is down 10.7%.  Combined, coal and steel make up nearly 50% of XME, and as you can see from the chart, have a big impact on its performance. 

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The product itself currently has $650 million in assets spread among 41 holdings. Allied Nevada Gold Corp, the funds largest holding, has a 4.5% allocation, so the fund isn't too top heavy.  XME has an expense ratio of 35 basis points and trades several million shares a day. From a technical perspective, XME was looking good at the end of 2013, as it was attempting to breakout but failed to reach that previous high in January 2014. XME has sold off sharply during the last 2 sessions, pushing it below its 50-day moving average. The next few days will be significant if XME can hold $38, which happens to be right around its 200-day moving average. 

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Tom PsarofagisComment
MINT Economies

Wall Street loves acronyms (BRICS, PIIGS, CIVETS),  and if there was some sort of "acronym ETF," I would be bullish. Fidelity and Jim O'Neill may argue over who deserves credit for coining MINT, but nonetheless lets take a look at what could be the next "hot" emerging acronym. 

MINT: Mexico, Indonesia, Nigeria, Turkey 

EWW: iShares Mexico ETF

This is the largest of the MINT products, with over $2.5 billion in assets. The fund is heavily invested in telecom and financials. EWW traded sideways for most of 2013, but ended the year down 3.5%

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EIDO: iShares Indonesia ETF

This is a $350 million product that is very heavily invested in financial and retail companies. Market Vectors  has a similar product (IDX). Both have nearly identical holdings and track very closely. 2013 was a rough year for both products, with EIDO posting a 24% loss. 

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NGE:  Global X Nigeria ETF

This is a fairly infant product launched in April 2013. The fund is quite small with about $7 million in assets. NGE posted over a 6% gain in 2013 and nearly half the fund is made up of financials and energy. 

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TUR: iShares Turkey ETF

Turkey has had quite the wild ride the last few years. After a solid 62% move in 2012, it completely fell off the cliff in mid-2013, ending the year down 28%. TUR currently has about half a billion in assets and is very heavily invested in financial stocks. 

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Tom PsarofagisComment
High SEAs

The Baltic Dry Index (BDI) is a commonly followed indicator that tracks the price of shipping raw goods on a given day.  In 2013, the index was up over 220% but 2014 has not been kind, down nearly 40%.  Investors looking to play the Baltic Dry Index can look at individual shipping names like Dryships (DRYS), Navios Maritime (NM), and Freeseas (FREE), among others. Now you will have to get into the nitty-gritty of each company too see how sensitive each is to changes in the BDI (are rates locked in, etc). Another more diversified alternative is SEA (Guggenheim Shipping ETF), which spreads it holdings among 25 global shipping companies. It is important to note that the ETF is pretty top heavy, with Danish shipper Maersk making up 20% of the fund. The ETF currently has $106 million in assets with an expense ratio of 65 basis points.

In the later half of 2013, SEA was trading in a pretty tight range, but still managed to post a 34% gain for the year. In late December, it broke out of its range and continued higher into 2014, hitting a 52-week high today. Looking at the daily 6-month chart below, SEA also recently broke out of a pennant continuation pattern, which suggests more upside. 

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Looking at a 3-year weekly chart one can see that the $22 level for SEA can be a tough resistance barrier to break (Previous support level in 2011).  If SEA can follow through with some momentum and break that level, it should see calm seas ahead. Depicted on the chart is an overlay of the BDI to show that although not perfectly correlated, SEA did pick up the major turn in 2013. Good luck out there.

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Tom PsarofagisComment
ETF Spotlight: Global X FTSE Greece 20 ETF (GREK)

On Monday, Greek Prime Minister Antonis Samaras announced Greece’s plan to exit the bailout program in 2014 and become a “normal county” again. Whether or not you agree with the data is another debate, but let’s take a look at a way to play the Greek equity markets.

Launched in 2011, Global X currently has the only pure-play* Greek ETF. With an expense ratio of 65 basis points, the fund currently has approximately $127 million in assets. The ETF currently has 23 holdings but is very concentrated, with the top 5 making up nearly half the fund. The consumer discretionary and financial sectors dominate the portfolio.

Performance wise, after forming a double-bottom in June, it hasn’t looked back. GREK has rallied over 24% this year and is among the top performing single-country ETFs. GREK will definitely be an interesting product to watch in 2014. Good luck out there.

*Coca-Cola Hellenic Bottling, the largest holding in GREK, moved its headquarters to Switzerland last year and switched its main market listing to London

*Coca-Cola Hellenic Bottling, the largest holding in GREK, moved its headquarters to Switzerland last year and switched its main market listing to London

Tom PsarofagisComment
Natty

Precious metals have eaten up all the attention in the commodities space this year, but it’s hard to ignore the recent move in Natural Gas. Although not perfect, UNG is a product designed to track the price of Natural Gas and is up nearly 22% since November. Recently, UNG broke simultaneously through a resistance level of $19.85 and its 200-day moving average. There still seems to be some momentum behind the move but could meet some resistance soon at the $21 price level. Since November, UNG has seen only a handful of negative days, so the move does seem over-extended and could mean-revert. Nonetheless, Natural Gas is something to keep on the radar. Good luck out there.

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Tom PsarofagisComment
Built Ford Tough

I visited an old friend in Detroit a few weeks ago and inspired me to take a look at Ford Motor Company. Since bottoming in August, Ford has rallied nearly 28% and closed up .72% today ahead of election Tuesday. Last week, Ford’s third quarter numbers beat Wall Street expectations and pushed the stock higher. Ford CEO Alan Mulally, the man credited for saving Ford from bankruptcy, also announced that he would stay with the company until 2014. The positive fundamental data coming out of Motown has also brought to light positive chart aspects for Ford. Starting in May, the stock has been forming an inverse head and shoulders pattern. The recent break out above the $10.50 neckline and the 200-day moving average is bullish for Ford. Based on the size of the pattern and the next significant resistance level, the upside price potential for Ford is approximately the $12.50 level. It is unclear to say what effect the Presidential Election will have on the auto-makers but Ford is a company worth watching. Good luck out there.

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Tom PsarofagisAuto Makers
Coal Mine

There has been a lot of interest brewing in coal following the Presidential Debates. Until recently, coal discussions have taken a back seat to natural gas, oil, and green energy. Following Mitt Romney’s comments showing his support for the coal industry, individual coal names such as James River and Consol Energy have had explosive moves in October. Below is an ETF that holds 35 coal names and replicates performance of the Global Coal Index. The last few years have been dismal for coal stocks to say the least. There is some positive news for coal stocks in that they have stopped falling and trading in a sideways pattern. There is still work to be done before we can call this a “reversal” or “rally” in coal stocks. Although the rounding pattern is positive for prices, I would like to see a breakout above $26 and make a move towards the $29-$30 level before I become a believer. The $29-30 level has been a significant support level for years so a break above that would be extremely bullish for coal stocks.  The United States is sitting on a tremendous amount of coal and as one of the largest coal exporters; will be very interesting to see what happens throughout the Presidential Elections. Good luck.

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Keeping up with the Dow-Joneses

The Dow Jones Industrial Average (DJIA) recently reached a 1-year high of 13,661 points. After correcting sharply in June, the DJIA has gone up, up, up but is beginning to show weakness in the charts. The DJIA has attempted twice to break out above the 13,600 level but is lacking the momentum and thus forming what’s called a double top. Typically a double top pattern is bearish and signals a reversal of the current trend.  From a bullish perspective, there are 2 significant support levels that may prevent the DJIA from breaking down. The first level is 13,300 (Also the 50-day moving average) and the second level is 13,000. Although we are seeing weakness from a momentum viewpoint, I would really get nervous if the chart breaks below the 13,000 level. The DJIA has not seen the 13,000 level since before the financial crisis, so a break below this level will definitely have a psychological impact on investors. Good luck out there. 

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Spanish Inquisition

Investors have kept a keen eye on Spain recently as the European sovereign debt crisis is gaining media attention once again. Spanish Prime Minister Mariano Rajoy announced yesterday that Spain has no plans to seek financial assistance from the European Central Bank.  Spanish 10-year yields seem to disagree with the Prime Minister and rates have dropped significantly from their summer highs. From a technical perspective, yields seem to have found some support around the 5.70% area. A spike in yields from this level may possibly pressure Spanish officials to seek financial aid. I also posted a chart of the IBEX 35, the benchmark index for the Spanish stock market. Looking at the charts, one can notice the inverse relationship between yields and equities. Technically, the IBEX chart is also looking interesting as it found a support level around 7600. This support level is quite significant because it just about coincides with the 200-day moving average and the momentum indicator has also found support and turning upwards. What we have now are 2 charts with an inverse relationship, sitting on solid support levels.  If yields shoot up, perceived “risk” increases and should send the stock market down breaking its support levels. The other scenario is that pressure from the ECB for Spain to seek aid, will keep rates lower and thus see the stock market move higher, holding its level of support.  Good luck out there.

Spanish 10-Year Government Bond Yields

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Up in the Air

Aviation has always been a passion of mine from a young age. I hold a Private Pilot license and rarely pass up an opportunity to be around aircraft, airports, etc. Today, I figured I would combine my interests and look at a chart of the AMEX Airline Index. This index tracks the price performance of the world’s major airlines. 2012 has been a rather boring year for the index in that it’s been trading sideways between the $35.50 - $39.00 range. Recently, the index hit the top of the trading range and instead of coming right back down to the lower portion, seems to be hanging around the top. This normally would be a sign of strength, but the momentum indicators are staying neutral and the 50-day moving average is pointing lower. These sideways trading ranges make it very difficult to make recommendations because there is no sense of direction (i.e neutral) and several indicators seem to contradict each other. For the time being, let’s just keep it on auto-pilot and wait for some clear direction. Good luck out there. 

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Tom PsarofagisAirlineComment
Wynn-ing

Casino stocks have been on a real hot streak lately. I have always been an admirer of Steve Wynn, so below is a 1-year chart of Wynn Resorts. Although the intermediate-term trend is down, an interesting pattern has been forming since June. The pattern is called an inverse head and shoulders and in this case, is positive for Wynn. The stock recently broke above its 200-day moving average in addition to having the 50-day moving average turn positive. Momentum indicators are confirming the up move in Wynn and I do not see any significant resistance until the $125 price level. Good luck out there. 

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Tom PsarofagisCasinoComment