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Growth And Value Go Down Together

The S&P 500 couldn’t hang on to its gains and snapped a five month winning streak in July. This is only the third down month in the last year.

Factor performance over the first three weeks of July was very different than the last week, which produced a challenging month-end for quantitative investors.

With the Fed policy approaching actual tightening, the market is trying to price in a rate hike in the next year or so. This is a rather typical market response.

We studied the five previous initial rate hikes and present the average pattern over the one year period prior to these events.

There have been several cases in the last couple years where credit and/or currency risk-off events never affected equities. We will soon find out if this is just another one of those. Caution is recommended.

              The Major Trend Index dropped 0.02 to 1.08 in the week ended July 25th, with four of five categories declining during the period. The string of weakened readings this summer prompted us to cut net equity exposure in our tactical funds on July 10th by 5-6% to 60%, and we stand ready to hedge equity positions further if our disciplines continue to deteriorate.

Net cash flows have now been positive for domestic equity ETFs in nine of the past ten weeks.  YTD tallies, however, remain muted compared to those seen at this time last year.

The Major Trend Index was unchanged at 1.10 in the week ended July 18th, hovering just 0.05 above its 0.95-1.05 neutral zone. The combination of inflated investor sentiment and weakening market internals is a negative one for the very near-term, and we cut net equity exposure in tactical funds to 60% (from 65-66%) to position for potential late-summer trouble.

This week, the domestic equity ETF subset saw net cash outflows for the first time in nine weeks, while bond ETFs experienced net cash inflows for the first time in seven weeks.

Domestic equity ETFs have seen ongoing positive net cash flows, while bond ETFs experienced a sixth consecutive week of net negative flows. ETF category flow trends continue to run counter to mutual fund flow trends.

The Major Trend Index rose 0.01 to 1.10 in the week ended July 11th, with large, opposing moves in the sentiment and market action work mostly cancelling one another out. Net equity exposure in the Core and Global Funds was trimmed by 5-6% last week to a current target of 60%.

              The Major Trend Index dropped 0.04 to 1.09 in the week ended July 3rd, matching its lowest reading since last August but remaining in positive territory. Declines in both our sentiment and market action categories drove the decline, and we responded this week by trimming net equity exposure in the Core and Global Funds to 60% (from prior levels of 66% in the Core Fund and 65% in the Global Fund).

Fund flow trends continue among broad fund genres.  While YTD domestic equity mutual fund net flows are now negative, other equity funds, such as foreign-focused, are picking up the slack.

In Q2, the Low P/E Tier was the best performing subset, up 6.6%. The Low P/E Tier also leads YTD +9.6%. The High P/E growth names are lagging severely YTD, up only 1%.

The S&P 500 gained 1.9% (price only) in June. Based on the 1957-to-date valuation metrics presented below, downside to its historical average is -14%, about 1% more than last month’s reading. The S&P Industrials’ downside to mean valuation (excludes Utilities and Financials) also increased slightly to -27%.

As we expected, at 250-270, the 10-year yield stayed within our narrow target range in June.

With the two factors decoupling, we examine if either one has been adding more value.

Newfound fund flow trends established midway through 2013 are still unbroken halfway into 2014. Even with net cash inflows resuming to bond mutual funds, the definitive shift in preference for equity funds, although more subtle, is still intact.