A Strong US Dollar Has Historically Benefited High-Quality Stocks
Since its inception in May 2010, the relative performance of the S&P 500 High Quality Ranking Index to the S&P 500 Index has shown a 0.43 correlation to the US Dollar Index (DXY). However, this correlation has jumped to 0.95 since Aug. 15, 2014.3 The dollar has been driven higher due in part to a favorable interest rate advantage. Given strong January US payroll growth and the European Central Bank’s implementation of quantitative easing, the outlook for a firm dollar is entrenched with recent signs of stronger European growth providing downside risk and the potential for a more two-way trade in the foreign exchange market.
High yield spreads drive quality
Widening high yield spreads have also played a role in driving quality. Since the Barcap U.S. Corporate High Yield to Worst ‒ 10-Year Treasury Spread Index hit a low of 222 basis points (bps) in the week ending June 20, 2014, it has widened to a recent peak of 493 bps in the week ending Dec. 12, 2014, and was still elevated 446 bps on Feb. 6, 2015.4
The relationship between high yield spreads and the quality factor, which can vary over time, is most clearly seen during periods of credit stress. To illustrate the relationship, the correlation between the Barcap index and the relative performance of the S&P 500 High Quality Index was 0.87 between June 20, 2014, and Feb 6, 2015.5 Strong January payroll growth and the 0.5% rise in average hourly earnings may put pressure on the Federal Reserve to normalize interest rates and could create some uncertainty and volatility in the high yield market as the market positions for rising short-term rates, in our view.
Macro environment puts quality factor in play
Investors tend to seek the quality factor during periods where earnings and dividends are vulnerable to weakness — as in the current environment with the recent increase in volatility, rise in the dollar and widening of credit spreads. Trends can and do change, but the quality factor could be in play for a while given today’s macro environment. Learn more about the quality factor and the PowerShares S&P 500 High Quality Portfolio (SPHQ).
1 Source: us.spindices.com/indices/strategy/sp-500-high-quality-rankings-index
2 Source: Bloomberg L.P., as of Jan. 30, 2015
3 Source: Bloomberg L.P. as of Feb 6, 2015, four-week average
4 Source: Bloomberg L.P., as of Feb. 6, 2015
5 Source: Bloomberg L.P., as of Feb. 6, 2015
Important Information
There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The Fund’s return may not match the return of the underlying index.