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INSIDE THIS EDITION:
The Rotation of Growth to Value
Chart of the Week: “The Broken Link Between Commodity Prices and Emerging Markets”
401k Plan Manager
Weekly Technical Comment
The Rotation of Growth to Value
Forbes reports the current U.S. bull market, as defined by a market which has not declined by 20%, has lasted over 8 years. During this period the U.S. stock market has experienced only 4 declines of 10% – 20%. If the current bull market lasts another 14 months it will be the longest bull market ever and will surpass the bull market ended in March 2000. No uninterrupted bull market has ever made it past 10 years.
The NASDAQ Composite Index has surged 14% in the first half of 2017 (the likes of Facebook and Amazon are up 30% – the former trades at 38x earnings and the latter 184x.) But the tide may be turning, with the tech-heavy NASDAQ below its 50-day moving average. Everyone in the media is suddenly talking about a rotation out of technology-dominated growth stocks into value stocks led by financials, healthcare, and (to a lesser extent) energy shares. We wrote about that when it started in our June 13th letter. The Technical Commentary section was entitled “Rotation Out of Growth Into Value is Long Overdue”.
Recent merger activity between Amazon/Wholefoods and Jana Partners/Panera Bread has made news headlines due to the hefty amounts paid for both companies. However, Citigroup data shows mergers and acquisitions are stalling in 2017. This is concerning because typically M&A activity is correlated to stock market prices. The number and volume associated with M&A deals is falling and is back to 2013 levels.
We have discussed over the past few weeks how risk levels, on a tactical and valuation basis, have risen for stocks. Having a slight bent towards being risk-adverse makes sense.
The Broken Link Between Commodity Prices and Emerging Markets
Commodity prices have a meaningful impact on many emerging market economies. This is the case, in part, because commodity exports are a large share of total exports in the emerging world and thus comprise a meaningful portion of their GDP. Our chart of the week shows that for some emerging market countries, commodity exports can be up to 50% of total exports and 25% of GDP, per an IMF study in 2010.
In 2017, crude oil has trended lower since February. In fact, after peaking at $54 per barrel in that month, WTI touched $42.50 on June 21st before a modest rebound off the bottom. Looking beyond oil, a wide range of commodities have underperformed this year including industrial metals and agricultural products.
In emerging markets, lower commodity prices like we see today have usually coincided with slowing economic growth, weakening currencies, increased capital outflows, and poor stock market performance. However, this year things are playing out differently as emerging market stocks have rallied despite declining commodity prices. Additionally, we have seen emerging market currencies move higher while exhibiting the lowest correlation to WTI crude oil in two years.
*Click to Enlarge Source: STA Wealth Management and Bloomberg
So why have emerging economies seemingly become less sensitive to commodities this time around? One factor could be that commodity pressures, especially in oil, are being driven by oversupply which has usually corrected itself as a result of being in a low-price environment. That doesn’t appear to be the case this time around. Secondly, there appears to be a global economic acceleration taking place at the same time the Chinese economy has stabilized thus keeping demand in check.
We believe that the transformation of emerging market economies lends an additional explanation for the decreased correlation between emerging market assets and commodity prices. More specifically, emerging market economies have been increasingly driven by technological advancement and consumer spending. Since 2010, the combined weight of the materials and energy sectors represented in the MSCI Emerging Market Index has steadily declined from 30% to 14%. At the same time, the weighting of the technology sector in the index has virtually doubled, increasing from 13% to 26%; the combined weight of consumer staples & discretionary sectors has increased from 11% to 18% during that same period.
These current index weightings highlight how emerging markets have become leaders, not followers, as FinTech and eCommerce have matured. Take India as an example. Currently, they are building a biometric database called Aadhaar intended to register all 1.3 billion people in India. So far nearly 9 out of 10 Indians have registered and can now easily pay their taxes, collect pensions and obtain certain welfare benefits. In China, the story is about online consumption. Last year, Chinese eCommerce giant Alibaba smashed the one-day online sales record with $17.8 billion worth of gross merchandise volume (GMV) during “Singles Day”, the world’s largest online shopping event. This one day haul easily exceeded the $6.7 billion sold during both Black Friday and Cyber Monday in the United States.
We highlight these points to say that although the importance of the supply and demand balance for commodities shouldn’t be forgotten, emerging markets are evolving and are showing signs that commodities are nowhere as important as they once were to the performance of emerging market stocks.
Weekly Technical Comment
Rotation from Growth to Value
Our June letter showed the following chart which is a “ratio” of the S&P 500 Value iShares (IVE) divided by the S&P 500 Growth iShares (IVW). After falling sharply during the first half, the value/growth ratio found support along its early 2016 low. Its 14-day RSI line (below chart) also showed the ratio to be in a very oversold condition. The RSI line is now rising. The value/growth ratio is finishing up its strongest performance of the year. The main point of the chart was to show that the decline in the ratio was overdone and that a rebound was overdue. Although technology selling has weighed on the market, gains in financials and healthcare have helped offset some of those losses during the month.
Technology Sector Undercuts 50-day Average
Everyone in the media is suddenly talking about a rotation out of technology-dominated growth stocks into value stocks led by financials, healthcare, and (to a lesser extent) energy shares. We wrote about that when it started in our June 13th letter. The Technical Commentary section was entitled “Rotation Out of Growth Into Value is Long Overdue”.
That message also showed healthcare stocks rising, and mentioned energy and materials as potential value gainers. The chart below shows the Technology Sector SPDR (XLK) slipping below its 50-day average today for the first time this year. After leading the market higher all year, tech is the market’s weakest performer during the month of June. That can be seen by the falling XLK/SPX ratio (red line).
The first chart below shows the Financial Sector SPDR (XLF) climbing to the highest level in three months. Financials have rallied this week on the back of rising global bond yields. Today’s gain is also tied to banks passing their stress test last week, which allows them to raise dividends and announce share purchases (which several of them have announced). Its (green) relative strength line started climbing earlier in the month when tech shares started selling off. Financials and healthcare are the two biggest parts of the “value” universe. The final chart shows the Healthcare SPDR (XLV) also surging in absolute and relative terms since the start of the month. Financials and healthcare are June’s two strongest sectors.
Weekly Snapshot of Global Asset Class Performance
Scott Bishop, our head of Financial Planning at STA Wealth, was recently invited to join Investopedia’s group of expert advisors that fields questions from users of their website. If you would like to follow Scott’s weekly thoughts on financial planning topics, check out his Investopedia webpage at the link below.
Featured Articles & Interviews
Mike Smith interviewed Michael Gaviser, Managing Director and Partner at KKR. Mike and Michael discussed Private Equities. What they are, who normally invests in private equity, and how today’s private equity market is different than it has been in the past.
Do you feel that you are ready for retirement? If so, try this quiz by given by the American College. Of the 1,200 individuals surveyed, 74% FAILED.
As you near or enter retirement, we have created this checklist for you, your family and your financial/tax team. The goal of this checklist is to help you get organized and to better determine if you are on track towards and/or have the information needed to help create and monitor your retirement plan now and through retirement.
Jennifer Mailhes, CPA
Scott Bishop, Executive Vice President of Financial Planning for STA Wealth Management hosts a special edition of STA Money Hour with guest Jennifer Mailhes, CPA. Jennifer is a shareholder and Managing Director with Doeren Mayhew Capital Advisors specializing in working with clients in the areas of M&A Advisory, Due Diligence and Exit planning areas. Throughout her career, Jennifer has provided business advisory services to help clients achieve their strategic or exit goals, from building business value to developing growth strategies and identifying exit planning opportunities. You can access Jennifer’s full bio here.
If you have any questions, please feel free to email me at email@example.com.
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Michael Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
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