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Rotation: Value Stocks are overperforming in September



In a week plenty of important economic news (Fed rate cut decision at Wednesday, Trade War concerns, Crude Oil price /CL spike after a drone attack, the recent ECB stimulus, the Friday Quadruple Witching, the huge spike in Repo Market rates yesterday), one is going unnoticed and I think it's crucial for exchanges in the mid-term: the "Great Rotation", as it has already been baptized by investors.

As you know, the Value stocks are those with low PE (Price/Earnings) and very stable fundamentals, and are opposite to the Momentum (or Growth) stocks, more focused on the aggressive growth of its value in the mid and long-term. This last, that have driven the bullish Wall Street rally for almost 10 years, is followed by the iShares Edge USA Momentum Factor ETF MTUM and includes giants companies such as Visa V, Mastercard MA, Microsoft MSFT, Disney DIS, among others. Meanwhile, the value stocks are followed by the iShares Edge USA Value Factor ETF VLUE which portfolio contains stocks like AT&T T, Intel INTC, IBM, and Bank of America BAC. Its average PE is 11.47 vs. 18.40 of the SP500. That's very undervalued, as you can verify in the chart above, a comparison between both ETFs performance in the last 5 years.



While MTUM has outperformed VLUE in the last 5 years, that began to change in August and VLUE's rally has accelerated month-to-date, as its risen 7.4.%, versus a 2.8% rise for the SP500 and a 0.2% decline for MTUM.



What happened?


However, the previous week a great move was seen in the positions of the "smart money", the great investors that drive the stock market. Their portfolios have moved (rotate) from active momentum to value stocks, and in an abrupt, almost atypical way. Why? Only they know... 

The fact is that these changes (the last rotation was in 2011) always impact in the markets, although we don't know the direction it will take. In numbers: while MTUM has outperformed VLUE in the last 5 years, but since August' last week the VLUE's rally has accelerated month-to-date, rising 7.4.%, versus a 2.8% rise for the SP500 and a 0.2% decline for MTUM. Here more technical details, with amazing charts.

Already some investors fear a downturn soon. But the fact is that this data only suggests that momentum stock are ready for a correction, and a rally in value stocks, but only depending on the economic behavior and next Fed decisions. A recession, or a slowing economy until 2020 invite the Fed to more rate-cuts to boost the economy and steepen the yield curve.




Russell 2000: time for an entry?


This rotation explains the divergence between the main indexes of the market: the last days of the Russell 2000 RUT, plenty of value stocks, has shown, by far, a much better performance than their pairs SP500 and Nasdaq. Undoubtedly, the Trade War affected and continues to affect much more these small companies with their production costs increase to the detriment of their margins and profits, but the index increase is there and seems nice.

On the other hand, the next sure Fed' rate-cut this week, which will reduce loans, will also favor Russell companies. This is understood as investors consider that increase in interest rates is especially expensive for smaller companies that tend to receive financing through adjustable-rate bank loans, rather than fixed-rate debt financing at which larger companies can access through capital markets. Their balance sheets may be adjusted in the short-term, and thereby improve the price of its shares and then the whole performance of the RUT index that in its last 52 weeks is still down 4.5%. These facts make IWM and IWN, ETFs that follow the Russell, great candidates for a buy in a mid-term, considering that, unlike the previous ones, they haven't reached their previous highs.


Technical analysis also helps the Russell 200 stocks: the daily chart of the IWM shows its price is breaking the resistance of a strong 52-week down trendline with heavy volume. Now above its 3 main SMA averages and the Ichimoku cloud, only need to retest this line at $155 to confirm the bullish breakout. Keep an eye on IWN, the ETF that follows only value stocks from the Russell. I presume a better performance there.