02/10/16   What is Normal?

Editor’s Corner

Ron Rowland

Fed Chair Janet Yellen kicked off her semiannual two-day testimony to Congress today. Her prepared comments sounded cautionary, and the initial questioning was anything but kind. As they usually do, members of the House Financial Services Committee were really giving speeches instead of asking questions. The gist of much of the early exchanges revolved around the Fed’s use of the words “normal” and “traditional” when describing the Fed’s monetary actions and the state of the economy.

Members took issue with the suggestion that the quantitative easing that zoomed the Fed’s balance sheet to nearly $4.5 trillion and the past seven years of near-zero interest rates were anything close to ordinary. Additionally, fighting deflation instead of inflation is not a typical economic environment, especially one that is multiple years into recovery mode.

In her prepared remarks, Ms. Yellen noted there have been declines in the number of people working part time but would rather be full time, and in the quantity of people available to work but have not recently searched for jobs. However, they are still higher than levels prior to the recession, point to continued slack in the labor markets, and leave plenty of room for further improvement.

According to the Fed, the uncertain economic outlook, financial conditions that have recently changed for the worse, and foreign economic developments all pose risks to U.S. economic growth. Given that backdrop, the timing of the next interest-rate increase remains ambiguous at best. In fact, the last paragraph of the prepared statement made it clear that lowering interest rates back to zero has not been ruled out.

Unsatisfied with past proclamations from the Fed, committee members attempted to get a clearer indication of when the next rate hike would occur or what conditions would trigger such a move. People asking the questions just don’t seem to understand that no one knows the answer. The Fed has said repeatedly said that it is on no predefined course, future moves will not be triggered mechanically, the path will be data-dependent, and a host of other phrases that translate to “we do not know” when the next move will occur.
Just to make sure the future path remained muddled, the discussion turned to the possibility of negative interest rates, like other central banks have been using. Fed Vice Chairman Stanley Fischer was recently quoted as saying that negative interest rates in other countries seem to be working better than expected. The theory behind negative rates is to generate stimulus by charging a fee to anyone parking cash on the sidelines. This in turn pushes money into riskier investments, which hopefully translates into faster economic growth.

Investor Heat Map:2/10/16


Today’s sector rankings are visibly separated into four distinct tiers. Utilities is the only sector in Tier 1 and stands heads above the crowd. Utilities alone is bucking the negative market trend, and that does not bode well for its future prospects. Historically, a single sector has been unable to sustain a strong rally when everything else is trending the other direction. That does not imply Utilities is destined for a fall, just that the 38-point momentum gap between it and the next tier will soon collapse. One possible scenario is that other sectors begin a rally in which Utilities does not participate. Tier 2 consists of Consumer Staples and Telecom. Often classified as defensive sectors, these two are barely treading water in this environment. Industrials, Real Estate, and Materials constitute Tier 3, and they happen to all be sectors in transition. Although deeply in the red, Industrials and Materials are climbing the rankings while Real Estate is falling. Tier 4, the worst-performing group, is also the largest group, consisting of five sectors. Their scores were widely dispersed a week ago but are now tightly bunched. Energy climbed off of the bottom, ending a nine-week hold on last place. Technology, Consumer Discretionary, and Financials all moved lower. Although Consumer Discretionary fell the furthest, dropping from sixth to tenth, the two-place decline of Financials landed it in last place.


Unlike the stair-step pattern of the sectors, the accompanying Style Edge chart shows a near-linear drop off in the momentum scores across the style categories. After many weeks without any significant shifts in their relative strength, a market preference for Value over Growth is starting to take shape. There is still an overwhelming advantage for larger capitalization stocks, and the top-ranked Mega-Cap category enjoys a substantial momentum point lead of 53 over last place Micro-Cap. However, Mega-Cap’s -25 momentum score is nothing to get excited about. Regarding the shift toward Value, Large-Cap Value climbed two places to second and knocked Large-Cap Growth three spots lower to fifth. Mid-Cap Value improved one position while Mid-Cap Growth went the other direction, putting them four places apart. Last but not least, Small-Cap Value climbed a notch higher, while Small-Cap Growth remains on the bottom.


The global categories also exhibit a pattern this week. For them, there is a clear winner, an obvious loser, and the vast middle ground follows a gentle downward slope. At the top, separating itself from all the others, is Canada. Just three weeks ago, Canada was in tenth place, and it had not been ranked any higher than that for 14 weeks. Then, Canada began its move, edging up to eighth two weeks ago, climbing to fifth last week, and claiming top-honors today. Canada established a low in mid-January, coincident with the trough for the Energy sector. It has managed to advance from that low, but the majority of its success is due to the extreme weakness among the other global categories. Such is the nature of “relative” strength. Nearly half of Canada’s recent gains can be attributed to the strength of the Canadian dollar against the U.S. dollar. China is on the bottom for a second week, and its momentum score is a full 30 points lower than any of the other global categories. The somewhat compressed scores and a volatile week combined to create many changes in the relative rankings. Pacific ex-Japan led the categories, climbing higher as it jumped from seventh to second. Emerging Markets also rose five places higher, and Latin America climbed four. Japan was the big loser, giving up its first-place honors and plunging all the way to seventh, and that was with the benefit of favorable currency strength. EAFE dropped four places, the U.K. fell three, and the Eurozone slid two places to land in tenth. The U.S. was relatively stable through this action, easing one spot lower to third.

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“It is not at all clear that the Federal Reserve Act permits negative [reserve deposit] rates. The Federal Reserve computer systems used to calculate and manage interest on reserves do not currently allow for the possibility of a negative [reserve deposit] rate, although these systems could be modified over time if needed.”

-Fed internal memo from 2010 authorized for public release late last month


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