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It was another large down day for markets, especially for the smaller sizes and high fliers of months past. That said, we wanted to provide a few bullet points to summarize the recent market action:

• The S&P 500 (SPX) fell over 2% on Thursday, reversing down into Os on its 20-point chart to print a lower top after its high at 3940. A move past 3820 would violate an initial level of support, with further levels offered around 3700. SPX still remains well above its bullish support line and holds on to a positive return for the year   
• The US Treasury 10YR Yield Index (TNX) crossed above 1.6%, matching levels last seen in February of 2020; 10YR treasury yields are now up over 50% on the year. For a further dive on recent moves in the fixed income markets, see our latest report here.
• The Bullish Percent for the NYSE (BPNYSE) reversed down into Os earlier this week and edged lower today, residing in a column of Os just below 70%. It is still a positive to see this indicator remain in high field position; however, should this push lower it could become a greater warning sign of dwindling market participation. BPNDX also retreated, now residing at the 43% level. 

On a different note, we saw small cap value moved into the fourth ranked DALI size and style group for the first time since 2014. Although outpacing mid cap blend by just one relative strength buy signal now, the move further underscores the strength in smaller sizes along with value-oriented areas of the market. Last time small cap value moved into the fourth ranked DALI size and style group it sat there for about 134 days before stalling out; however, as depicted below, most small cap value rallies in the past 15 years were short lived – climbing to the fourth rank to only cool off about a month later (the exception being 2008-2009). While large cap equities have been a dominant force for the better part of the past decade, we did see small cap value demonstrate exceptional leadership in the early 2000s, more specifically January 2003 – July 2007, where the group held the number one rank for 1,222 days (just over three years). This, albeit loosely and on average, aligns with a recent factor study conducted by Russell which empirically demonstrated that size and value have anticipated subsequent inflections in GDP growth, or when the outlook for the economy is favorable (Source: ftserussell.com). Although small cap value has not been able to sustain leadership in the past, market dynamics are constantly changing and it will be interesting to see if this time is any different.

As we have mentioned recently, inflation expectations have increased to their highest levels in years. One of most common methods of positioning a portfolio for rising inflation is to include an allocation to commodities. As a result, many investors may be wondering about the best way to gain exposure to commodities.  Prior to the inception of ETFs commodities were largely only accessible via futures which were primarily the domain of institutional investors. ETFs now offer average investors relatively easy access to commodities. However, there are a few differences between equity and commodity ETFs to be cognizant of.

Many ETFs gain exposure to commodities via futures contracts which means that most of these funds will generate a K-1, unless they use a structure specifically designed to avoid it. Other ETFs, specifically precious metals ETFs, are backed by physical metal and are taxed as collectibles, which is typically a higher tax rate than capital gains. Finally, there are ETNs, ETNs don’t hold futures or physical commodities, they are a debt obligation of the issuer. These funds are not taxed as collectibles and they don’t generate a K-1; however, investors in ETNs are exposed to the credit risk of the issuer. Below is a list of commodities and funds that can be used to gain exposure to each.

Crude Oil

The largest oil ETF on the market in terms of assets is the United States Oil Fund USO with over $3 billion in AUM. USO gains exposure to crude oil through futures contracts and investors in the fund will receive a K-1. The fund holds futures contracts up to ten months out, so there will be some difference in the performance of USO and the front month oil contract, which is what is typically quoted when discussing the daily performance of oil. This brings up another point about ETFs that hold futures – roll yield. In a normal market the oil futures curve is in backwardation, i.e., the futures price is below the spot price. If the price remains the same, the futures contracts that the fund holds “roll” up the curve to the spot price, generating positive roll yield. When the market is in contango, the opposite is true, which produces negative roll yield. Roll yield is not the most important aspect to the overall performance of oil ETFs, but is a factor to be aware of. You can check to see the current state of the oil futures curve on the CLCONTANGO chart.

Those who do not want to receive a K-1 can consider the Proshares K-1 Free Crude Oil Strategy OILK. Like USO, OILK also gains exposure to oil via futures contracts; however, it is structured to avoid generating a K-1. One thing worth noting is that, while many people try to avoid a K-1, typically the K-1 tax treatment is actually better.

Gold

The largest gold ETF on the market is the SPDR Gold Trust GLD. GLD, like most other gold ETFs on the market, holds physical gold and will receive the collectibles tax treatment discussed above. Another large gold ETF is the iShares Gold Trust IAU; IAU also holds physical gold so avoiding the collectibles tax treatment may not be possible through ETFs here.

Silver

The iShares Silver Trust SLV is by far the largest silver ETF on the market with more than $17 billion in AUM. Like GLD, SLV also holds physical silver. Investors who want exposure to silver but without the unfavorable tax treatment could utilize an ETF like the Global X Silver Miners ETF SIL. SIL is an equity ETF that holds silver mining companies; while the performance of these stocks is correlated to the price of silver it does not offer the pure exposure of a fund like SLV.

Those who want exposure to a basket of precious metals in a single ETF could consider the Invesco DB Precious Metals Fund DBP. DBP currently holds 76.70% gold and 23.3% silver. Unlike most other precious metals funds, DBP’s portfolio consists of futures. This means that investors in the fund will receive a K-1, which may provide more favorable tax treatment than funds that hold the physical metals.

Industrial Metals

The largest industrial metals ETF is the Invesco DB Base Metals Fund DBB. DBB’s portfolio includes copper, aluminum, and zinc. As with the Invesco’s precious metals fund, the fund holds futures and thus investors will receive a K-1.

Investors looking for exposure only to copper can consider the United States Copper Fund CPER. Like DBB, CPER gains its metals exposure through futures, so investors will receive a K-1.

There are funds that offer exposure to single industrial metals including tin, aluminum, and lead; however, all of these funds have low levels of assets, many under $10 million. As a result, liquidity may be poor, and they are likely excluded from the approved list at many firms.

General Commodities

There are options for those who want exposure to a basket of commodities in a single fund, like the Invesco DB Commodity Index Tracking Fund DBC. DBC offers exposure to a wide range of commodities including crude oil, natural gas, precious metals, copper, industrial metals, and agricultural products. DBC does generate a K-1.

Luckily for those who want general commodities exposure without a K-1, DBC has a K-1 free counterpart, the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF PDBC. PDBC offers exposure to the same basket of commodities as DBC.

The rise in volatility across domestic equity markets over the past week led to some rotation among the sector view of the Asset Class Groups Scores (ACGS) page. The financial-banks group continued higher to an average score posting of 5.07, making it the highest-scoring sector representative on the ACGS page, and the third-highest scoring group out of all 135 groups through trading Wednesday. Financial-banks beat out technology for the top-ranked sector position, although the technology group still sits in close proximity to the top position with an average score of 5.00. This high score position for financial banks comes after a prolonged period of underperformance, as the space had scored lower than the technology group since May 2018. Although the financial-banks group only has data available dating to early-2011, this almost three-year period of underperformance marks its longest such stretch in the group’s history. In fact, the two groups were separated by almost 3 full score points in September of last year, which was also the largest score dispersion the two areas had seen. Since that time, technology largely moved sideways in score, remaining in a high field position but not necessarily improving. The financial-banks group, however, stormed higher, which is indicated by its average score direction of 4.00. While the technology space has not begun to deteriorate in score all that much, the vast outperformance of other sectors in recent weeks certainly speaks to the increased likelihood of further weakness moving forward.

Another group that has shown significant improvement is the energy-natural resources space, which is closing in on the 4-score threshold at a recent group score posting of 3.95. This marks the highest score territory for energy since April 8, 2011, when the group briefly moved north of 4.00 for a single trading day. Other than that instance, you need to travel back to before the 2008 meltdown in commodities to find the group in higher score territory. With the energy space moving significantly higher this week in the DALI rankings, you may be wondering why the group still sits in a lower relative position on the ACGS page. The answer to that question lies in the differences between the strictly relative strength-based rankings underlying DALI, and the variety of factors that go into the fund score system that underlies the ACGS page. As a refresher, a fund score is made up of 19 different factors, which a separated into thirds: trend analysis, relative to market analysis, and relative to peer analysis.

We will use the Energy Select Sector SPDR Fund XLE as an example for the broader energy space, as the broad representative also possesses a recent score posting of 3.95. In looking at the score details, we can see that the majority of trend analysis factors are positive for XLE, which makes sense given the fund's 32.69% year-to-date return. However, many of the relative to market and peer comparisons incorporate 1-year trailing performance percentile rankings, and XLE still sits in a low field position with a loss of 2.61% over that time frame. If XLE and other energy funds continue to demonstrate relative strength over other domestic equity areas, these percentile rankings have the potential to move higher fairly quickly.

*We originally noted NET as hitting its stop which was incorrect and has been corrected. NET Cloudflare Inc Class A remains above its $68 stop.

Daily Option Ideas for February 25, 2021