Monday, August 1, 2016

Performance breakdown tells a simple story of a risk-on environment

Decomposing returns across styles, sectors, countries, and fixed income through looking at ETF performance provides a clear picture of a risk-on environment. Our trend and momentum indicators suggest that this performance will continue in August. Most trends as measured by different look-back periods are positive and our simple break-out models that looks at past highs for buys are showing consistent signals.

The style sector performance shows the biggest moves with small cap, growth, and emerging markets  which are also the higher risk styles. This performance is in contrast with the high divided style ETF which has been the best performer for the year, but showed lower returns in July.

The energy sector was the largest under-performer for July. All of its trends have turned down. The best performers were the risky technology and health sectors and the consumer discretionary sector. The other under-performers were utilities which have been a defensive sector and consumer stables which is another supposed safe choice for investors. Clearly, investors moved away from  the higher cash flow sectors on a relative basis which is a clear signal of greater risk-taking. 

Country equity indices saw big gains in the risky Brazil, Taiwan and South Korea markets, but there also was strong performance in the many Europe country funds. These gains were based on the the perception that there is less risk in current post-BREXIT world. We don't believe this risk has gone away even though the doomsday predictions pre-vote may not seem as likely. The BREXIT transition to date has been somewhat orderly, albeit Article 50 has yet to be invoked. 

Brazil, the host of the Olympics, has received a lot of bad press in the last month but that has not stopped investors from being large buyers. Similarly, the negative news about a Turkish coup did not dampen the positive returns in the now uncertain investment climate in this country. 

The bond sector was mixed, as expected with a risk-on environment, but the long bond (TLT) index still showed a close to 2 percent gain. Credit sectors and emerging markets returns were also positive based on spread moves.

The consistency of trends across a wide variety of styles, sectors, and countries provides clear evidence that these are not isolated return moves but related to a common factor associated with an investor desire to take on more risk. With monetary policy still loose around the world and risks perceived to be more under control albeit in a low growth lower earnings environment, investors have made a clear play for  risky assets.

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