Hunting for Growth

In the past few months, we learned that 4th quarter S&P 500 earnings declined 14%, their worst year-over-year decline of the expansion.

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With growth harder to come by, investors have been actively bidding up growth names wherever they can find them.

The Russell 1000 Growth Index (IWF) has outperformed the Russell 1000 Value Index (IWD) by over 5% thus far in 2015. We have seen similar outperformance in small cap growth (IWO) over small cap value (IWN).

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Looking at the difference in sector weighting between Russell 1000 value and growth indices, we can see that growth has benefited from the outperformance in Tech and Consumer Discretionary with an overweight in those sectors. Growth has also been aided from an underweight in Financials, Energy, and Utilities as those sectors have declined thus far in 2015.

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Sector performance in the first quarter has largely followed revenue growth, with Tech, Consumer Discretionary, and Health Care posting above-average revenue growth while Financials, Utilities, and Energy have shown below-average growth.

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With the release of 1st quarter earnings in a few weeks, it will be interesting to see if the outperformance of growth over value persists. If growth remains scarce, we could see a continued widening in this relationship. On the other hand, if growth comes in stronger than expected, particularly in the “value” overweight sectors such as Financials and Energy, we will likely see a convergence in performance.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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The Currency Hedging Boom

The most dominant theme thus far in 2015 has been the global currency war, where central banks are fighting one another with new easing measures on a daily basis to debase their currencies. By my count, there have already been at least 28 easy money announcements in 2015.

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The direct by-product of this race to debase has been the unprecedented boom in currency hedging. With central banks intent on crashing their currencies to lift their equity markets, U.S. investors have caught on to the game.

Out of the top 10 ETF inflows in 2015, 4 are in currency hedged ETFs (HEDJ, DBEF, DXJ, and HEFA) for a combined total of over $18 billion.

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Why the stampede into hedged ETFs? Two main factors are at play.

First, you have the compelling narrative of massive QE in Japan and Europe, a crashing Yen and Euro, and the perception that there is no better way to take advantage of this than through hedged equities.

Second, performance chasing is in full effect as there have been few asset classes with better performance of late than hedged equities in Japan and Europe. Over the past five months hedged Japan (DXJ) and hedge Europe (HEDJ) are up over 32%.

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A good story coupled with strong momentum is simply too much for investors to resist, especially when a crashing Euro/Yen is viewed as a “can’t lose” trade. When faced with the choice of a hedged ETF vs. a non-hedged version, the performance disparity is so glaring it is no surprise investors are overwhelmingly choosing to hedge. Since the start of 2014, the hedged Europe ETF (HEDJ) is up over 25% while a comparable unhedged version (VGK) is down 1%. Why the enormous gap? The Euro is down over 21% during that time.

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Since Japan upped their QE program in 2011, the Yen has depreciated over 37% and the hedged Japan ETF (DXJ) has outperformed the unhedged version (EWJ) by 63%.

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All of this hedging has been highly profitable but it will only continue to be so as long as a) the currencies continue to depreciate and b) the market continues to perceive such depreciation as bullish for equities. The danger is that few investors buying in today are likely to realize that they are predominately playing a currency debasement game in buying these hedged equities. The rolling correlation between the Yen and the Nikkei, at -.94, illustrates just how dependent Japanese equities have become on a weaker Yen.

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Should there be an upward reversal in the Yen or the Euro, we would see the opposite effect and currency hedging would lower returns. The contrarian in me would say that given the massive inflows into these ETFs, perhaps we are closer to the end of the easy money debasement than investors believe. In the past year alone, we have seen assets in the hedged Europe ETF (HEDJ) increase from $1 billion to over $16 billion.

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At the same time, we are seeing record net short positions held by speculators in Euro futures.

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Perhaps these investors and futures traders will continue to be right and the Euro and Yen will fall from here to eternity. But on the off chance it isn’t as easy going forward, a modicum of caution may be warranted.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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The Great Appeasement and the Burden of Proof

After six years and two months of 0% interest rates with three rounds of quantitative easing (QE) in between, the Federal Reserve chose to finally remove the word “patient” from their official statement. Hawkish at last! Not so fast. I once heard that you should never underestimate the dovishness of Janet Yellen and she delivered on that reputation on Wednesday.

In a grand gesture of appeasement, the Fed took a hatchet to their projections (called “dot plots”) for the path of the Fed Funds rate. A few weeks ago I wrote about the wide gap between market expectations (Fed Fund Futures) and Fed’s dot plots. The market was still dreaming of doves, I explained, and aggressively calling the Fed’s dot plot bluff.

Well, those dreams came true yesterday as the Fed chose to move significantly closer to the market, shifting its dot plot projections lower in 2015, 2016, and 2017. From the previous 2015 year-end median rate of 1.125%, they moved all the way down to 0.625%. This signifies a shift from 4-5 rate hikes in 2015 to only 2-3.

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Market expectations moved lower as well, with Fed Funds Futures now pointing to the first rate hike as far back as October and a year-end rate on only 0.425% (indicating 1-2 hikes). The implied odds of a hike in June, which many had been talking about as possible before the meeting, moved all the way down to 9%.

In a euphoric ramp reminiscent of so many dovish-leaning statements over the past few years, equity markets exploded higher with algorithmic traders keying off the shift in dot plots. If you hadn’t seen the release, you might have thought by this reaction that a 4th round of quantitative easing had been announced. That’s how dependent the market has become on a continuation of 0% Fed policy.

If there was any doubt left that by removing “patient” it actually meant something more hawkish, Dr. Yellen set everyone’s mind at ease in saying the following: “just because we removed the word “patient” from the statement doesn’t mean we are going to be impatient. Moreover, even after the initial increase in the target funds rate, our policy is likely to remain highly accommodative.”

Brilliant. So after over six years of 0% rates the Fed still feels the need to promise to remain highly accommodative if they ever raise rates in the future.

What are they so afraid of, you ask? Isn’t the Unemployment Rate, at 5.5%, lower than in 1994 and 2004 when they started raising rates in the two previous cycles?

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Yes, but Fed policy stopped being about economics a long time ago. As I have argued, this is simply about pushing short-term asset prices higher and higher in pursuit of a virtuous “wealth effect” that has yet to occur. It is also about the global currency war and given unprecedented strength in the Dollar over the past 9 months, the Fed apparently was not prepared to wave the white flag.

The Burden of Proof

All of which of course begs the following question which has yet to be asked of Janet Yellen at a post-FOMC press conference. The stock market has already more than tripled since 2009 but this has been the slowest growth recovery in history, both in terms of real GDP and real wages. Shouldn’t the burden of proof be on Fed to explain how continuing their policy of 0% is helping and not hurting the economy?

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As Stan Druckenmiller and Bill Gross have argued recently, the Fed’s policies are no longer serving the best interests of the real economy and capitalism. They are simply serving the short-term interest of the financial markets, encouraging financial engineering and speculation over investment in employees and capital. Unfortunately, that is not how you promote long-term growth. As I wrote recently, the Fed cannot serve two masters anymore: it’s either the real economy or boosting short-term asset prices with hopes that will encourage spending (I say short-term because unless you believe that trees grow to the sky, all the Fed has done is borrow returns from the future).

On Wednesday Dr. Yellen and the Fed once again chose to defend the short-term stock market over the real economy. With April now definitively off the table, I suppose we’ll have to wait until June to find out if they have a change of heart.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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