Opportunities and Risks in 8 Funds

01/15/2018 3:42 pm EST

Focus: MARKETS

Landon Whaley

Editor, Gravitational Edge

A look at opportunities and risks in eight funds: SPY, FXI, LQD, OIL, TLT, UUP, FXE and GLD. writes Landon Whaley of Focus Market Trader.

The SPDR S&P 500 ETF Trust (SPY) gained 1.7% last week. SPY’s Fundamental Gravity remains bullish because U.S. economic growth continues to accelerate. Growth is accelerating but inflation may be starting a slowing phase.

December’s reading for all three critical inflation measures (CPI, PPI and Import prices) slowed from the previous month. If this trend of growth up and inflation down continues then tech stocks will pick up speed and energy stocks will underperform, on a relative basis.

Quantitatively, our proprietary trend indicator, Social, shows that SPY is in party mode once again, which indicates higher prices ahead. Barometric, an indicator of buying pressure, is still registering the highest readings in a decade.

Behaviorally, investors are not bullish enough but are beginning to build decent sized long positions in S&P futures. Clearly these folks don’t understand the power of the Fundamental Gravity and are simply chasing the S&P’s performance to start 2018. All three Gravities are bullish, and so is our bias.

The iShares China Large Cap ETF (FXI) gained 2.6% last week. Fundamentally, it doesn’t get more bearish for Chinese equities than when Chinese economic growth slows while inflation accelerates.

While recent growth data has been a mixed bag, inflation has been clearly trending higher. China’s inflation rate accelerated to 1.8% in December led by food inflation, which is now sitting at a fourth month high.

Quantitatively, when Chinese growth slows while inflation accelerates, Chinese equities typically get monkey-hammered. During these economic regimes, FXI averages a −9.6% loss, while experiencing a maximum drawdown of −28.1%.

The bottom line is that when Chinese economic growth slows while inflation is running, it usually leads to a crash in Chinese equities. Behaviorally, investors have continued to plow money into Chinese equity exchange-traded funds in the first few weeks of 2018. This tells me investors are blatantly ignoring the current state of the Chinese economy and the magnitude of downside risk for Chinese equities. All three Gravities are bearish, and so is our bias.

The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) declined 5 basis points last week. From a Fundamental Gravity perspective, monetary policy since the Financial Crisis has provided an extremely conducive environment for credit markets.

The problem is that the Fed is now tightening in an untested way, through the balance sheet. Investors believe this balance sheet unwind will be seamless, but I’m not convinced.

Either way, this makes LQD’s Fundamental Gravity murky, at best. Quantitatively, things are leaning a bit bearish. Credit markets have experienced two straight years of positive excess returns, yet it’s been more than two decades since they have put together a streak of three straight years. Behaviorally, investors continue to throw money at corporate bonds of all shapes, sizes and qualities. However, investors have yanked over $500MM from LQD in just the first 9 trading days of 2018. When the three Gravities are not aligned, as with LQD currently, that’s when we hold a neutral bias on a market.

The iShares Barclays 20+ Year Treasury Bond ETF (TLT) declined 95 basis points last week. TLT’s Fundamental Gravity remains bearish as long as U.S. economic growth continues to accelerate.

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However, right now the primary fundamental catalyst driving U.S. Treasuries is the latest Fed rate hike, and that is bullish. Quantitatively, TLT has nearly twice as much upside potential as downside risk in the six months following a Fed rate hike. Our proprietary trend indicator, Social, is currently in sleep mode but once it enters party mode, it will indicate a new bullish trend.

Behaviorally, investors have recently yanked a ton of money from the four largest Treasury exchange-traded funds and these outflows are continuing here in 2018. Investors have pulled approximately $30MM from TLT in just the last two weeks.

These ETF outflows tell me that investors are still buying the misconception that a Fed rate hike pushes U.S. yields higher. But history shows us that investors don’t sell bonds in response to rate hikes; rather, they gobble them up. All three Gravities are bullish, and so is our bias.

The Powershares DB U.S. Dollar Index Bullish Fund (UUP) declined 1.0% last week. UUP’s Fundamental Gravity remains bullish as long as U.S. economic growth continues to accelerate. However, right now the primary fundamental catalyst driving the greenback is the latest Fed rate hike, and that is bearish. Quantitatively, UUP is all downside when the Fed raises rates.

The U.S. dollar averaged a negative return in the six months following each of the last four Fed decisions to lift rates. In addition, our trend indicator, Social, has been in hangover mode since December 20, indicating a decidedly bearish downtrend.

Behaviorally, investors are already hip to the bearish tone of the USD following a Fed rate hike, but the truth is they’ve been bearish for a while now. In fact, UUP has seen consistent outflows throughout the last year and another $30MM outgoing to start 2018. In the futures markets, institutional investors have been extremely bearish on the greenback for months now, and remain so. All three Gravities are bearish, and so is our bias.

The Guggenheim CurrencyShares Euro Trust (FXE) gained 1.2% last week. FXE’s Fundamental Gravity remains bearish as long as the ECB stands ready to reverse their current policy course. The ECB has consistently reiterated, “If the outlook becomes less favorable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the APP in terms of size and/or duration.”


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Quantitatively, we are receiving conflicting information. Social, our trend indicator, is telling us it’s party time and the euro’s price action is confirming this signal. However, Barometric, our proprietary indicator of buying pressure, is sitting at 3-year lows. This is telling me there is a lack of conviction behind this latest FXE rally. Behaviorally, investors are massively long the euro, holding nearly three times the average positioning over the last twelve months. When the three Gravities are not aligned, as with the euro currently, that’s when we hold a neutral bias on a market.

The iPath S&P GSCI Crude Oil Total Return Index ETN (OIL) gained 5.9% last week. OIL’s Fundamental Gravity is shifting from bearish to bullish, capped off by the “further adjustment” provision in the latest OPEC production cut agreement.

This provision gives OPEC the opportunity to adjust production if prevailing market conditions warrant, which I’d say gives crude a slightly bullish Fundamental Gravity. In addition, as crude oil supplies have reduced, short-term oil contracts have become more expensive than those with longer maturities.

This type of market structure makes it profitable to be long, as each month investors roll into cheaper contracts further out in maturity. Being long oil is providing a positive annual return, even if oil stays flat, for the first time since 2014. Can you say “bullish?” Quantitatively, Social is signaling that OIL is in full party mode, and Baromotric is confirming a high level of conviction.

Behaviorally, investors are long, strong and massively bullish for crude oil. Despite the Behavioral Gravity indicating a strongly consensus trade, crude oil’s Fundamental and Quantitative Gravities are bullish, and so is our bias.

The SPDR Gold Shares ETF (GLD) gained 1.3% last week. GLD’s Fundamental Gravity remains bearish as long as U.S. economic growth continues to accelerate. However, right now the primary fundamental catalyst driving gold is the latest Fed rate hike, and that is bullish.

Quantitatively, Social is signaling that GLD is in full party mode, while Baromotric, our proprietary measure of buying pressure, is bouncing off the lowest levels in twelve months. This means buying pressure is building during GLD’s recent run higher and when you couple that with falling volatility, it doesn’t get more quantitatively bullish.

Behaviorally, investors have been taking money from gold-inspired exchange-traded funds for months now and that has continued here in 2018 with another $350MM pulled from GLD in the last two weeks. In the gold futures market, investors are leaning slightly long, but are extremely underweight compared to the long positions they’ve held in the last twelve months. The Behavioral bottom line is that investors aren’t bullish enough given how gold typically reacts in the wake of a Fed rate hike. All three Gravities are bullish, and so is our bias.

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