The investment trend can be your friend until, of course, it turns against you.
With economically sensitive sectors of the market selling off in October and November, and more defensive ones holding up best, momentum-oriented ETFs have given up their smart-beta industry-leading gains this year.
However, these are not static portfolios, so it can be helpful to see what has or could be shifting due to rebalances.
Heading into this holiday season, investors have been pressured by concerns about congressional gridlock, the expected ongoing tightening of monetary policy, the impending peak in earnings-per-share (EPS) growth and the impact of falling oil prices, according to Sam Stovall, chief investment strategist at CFRA.
However, slumps like the latest one historically have led to end-of-year rallies, and investors will likely look for a possible moderation of the Fed’s rate-tightening tone and evidence that analysts have become sanguine on 2019 EPS growth prospects.
Consumer Staples & Health Care
On a weekly basis, CFRA assesses the 11 GICS sectors and more than 100 subindustries of the S&P 1500 index based on their 12-month relative strength. At the sector level, the relative standing for consumer staples and health care improved since the end of September, while the energy, industrials and information technology sectors weakened.
Meanwhile, consumer discretionary and financials were unchanged despite some high-profile individual stock declines. Looking back six months, the trends are similar, though consumer discretionary strengthened while financials weakened.
CFRA offers its clients an Industry Momentum model portfolio, available on MarketScope Advisor, which is reconstituted monthly based on our relative strength analysis. Currently, there are 20 stocks across unique industries. In September and October, the apparel retail, food distributors, food retail, technology hardware, storage, peripherals and systems software industries were added to the portfolio.
Investors seeking an ETF approach favored the iShares Edge MSCI U.S.A. Momentum Factor ETF (MTUM), a $9 billion fund that gathered $3 billion in new money this year.
Recent losses pushed the ETF into the red as of Nov. 20, after outperforming the broader market for much of 2018. As of late November, MTUM was heavily exposed to technology (41% of assets), consumer discretionary (15%), financials (13%) and industrials (11%), but had minimal exposure to consumer staples (3%).
However, the MSCI index behind MTUM will conduct a semiannual rebalance at the end of November, based on price momentum—not valuation screens—which will likely result in some changes to its constituents.
For example, within the tech sector, the relative strength for three of MTUM’s largest subindustries (data processing, outsourced services and semiconductors in the technology sector; and aerospace and defense in the industrials sector) have weakened in recent months. Stocks here include Boeing, Intel and Visa.
Meanwhile, based on the sector shifts at other momentum ETFs following their rebalances, exposure to the health care sector (9%) could climb higher.
Let’s look at the First Trust Dorsey Wright Focus 5 ETF (FV), a $2.3 billion ETF that holds just five industry or sector-oriented ETFs from within the fund family. Twice a month, relative strength analysis is conducted to identify which ETFs have climbed into or fallen out of favor.
In November, FV added the First Trust Health Care AlphaDEX Fund (FXH) and sold its stake in the First Trust Industrials/Producer Durables AlphaDEX Fund (FXR). Currently, FV owns two health care ETFs, two technology ETFs and one internet ETF that holds a mix of technology, consumer discretionary and communications services companies.
FV is more concentrated at the sector level than others, but is diversified at the stock level.
Smart-Beta ETF Styles Not The Same
Despite being more frequently rebalanced than MTUM, FV’s 4.7% loss year-to-date through Nov. 24 was much wider than the fractional gain for the iShares offering. This highlights that not all smart-beta ETFs in a style will perform in sync with one another.
Source: CFRA Research, Nov. 23, 2018
Meanwhile, the Invesco DWA Momentum ETF (PDP) is a $1.4 billion momentum ETF that is rebalanced quarterly. PDP is more diversified at the sector level than MTUM or FV, with just 27% in technology, 22% in industrials, 19% in consumer discretionary and 12% in health care.
According to our research, PDP holds fewer consumer discretionary stocks and more health care stocks than it did three months ago. Booking Holdings, Churchill Downs and Scientific Games are among the consumer discretionary stocks recently removed from PDP.
Meanwhile, Boston Scientific, Humana and West Pharmaceutical Services are examples of newly added health care positions. Year-to-date, PDP’s 1.3% decline fell between previously mentioned momentum ETF peers.
PDP had a similarly low 2% stake in consumer staples as MTUM, but according to our research, the 12-month relative strength for the sector has significantly improved since September, making it likely it will form a more meaningful portion of momentum ETFs.
CFRA will be watching to see how MTUM’s stock and sector exposure shifts following its upcoming rebalance—because what’s inside the portfolio is a bigger driver of an ETF’s future returns than its past performance.
This article originally published on MarketScope Advisor on Nov. 26, 2018. Visit https://newpublic.cfraresearch.com/etf/ to gain access.