VEU - Stocks Retreat Amid Higher Rates In February Buyback Stocks (PKW) Come Under Fire

Summary

• The S&P 500 notched a modest loss in February, driven by an inflation scare.
• A strong consumer poses problems for Chair Powell and the FOMC as it seeks to slow the rate of increase in consumer prices.
• Buybacks were attacked during the month, but then got the backing of Warren Buffett. I spot key technical levels on the PKW BuyBack Acheivers ETF.

February was a tough month for the bulls, but the damage was not too severe. Equities pulled back amid rising interest rates as January’s optimism, caused by a renewed hope that inflation would be on the mend quickly, was subdued somewhat.

All in all, the S&P 500 fell 2.5% while the tech-heavy Nasdaq composite dropped by less than a percent. The Russell 2000 ETF ( IWM ) declined by 1.8% while foreign equities were under particular pressure, giving back a sizable chunk of their 2023 gains with a 4.3% monthly fall.

Stocks, Bonds Fall in February

The U.S. Aggregate Bond Index ETF ( AGG ) fell 2.7% as the 10yr Treasury yield climbed more than 60 basis points off its Groundhog Day nadir to close near its highest level since November. The U.S. Dollar ETF ( UUP ), meanwhile, rose 3.3% to just about its highest value of the year despite sovereign bond yields rising across the world, particularly in Europe.

U.S. 10yr Treasury Rate Near 4% After Dipping to 3.33% in Early February

All eyes are on the Fed as traders are now more hawkish than Chair Powell. It used to be that the Fed’s jawboning wasn’t believed by investors, but, according to data from the CME Group, the peak rate for the Effective Federal Funds Rate is now seen above 5.4% - up more than half a percentage point from the low in January and well above the Fed's official forecast. What’s more, the “higher for longer” narrative is seen in the terminal rate now potentially not hitting until October this year.

Fed's Terminal Rate Priced at 5.41% (October)

Amid all that uncertainty and rate volatility, one market has been conspicuously calm: Commodities. Oil prices have been stable in the $70s while gold gave back about 5% in February due to a stronger greenback and rising real yields. Bitcoin, meanwhile, failed to rally much above the $24,000 price point after exhibiting impressive price action following the FTX debacle.

WTI Crude Oil Volatility Index (OVX): Near 52-Week Lows

One thing is for sure – the consumer remains strong and resilient. And that's the problem. High retail sales and decent numbers reported by consumer companies lately mean the Fed must keep its foot on the economic brake pedal to tame inflation pressures.

Due to strong demand, Q1 GDP is now seen perhaps above 2% (if the Atlanta Fed GDPnow model is right) while Q2 and Q3 are forecast to be contractionary quarters if the consensus is correct. Market analysts also are bringing down their earnings outlooks for this year and next as the Q4 reporting season saw about a 2-to-1 ratio of firms issuing negative to positive guidance.

Technical Recession is Forecasted

One group of stocks, high-buyback firms, came under attack by President Biden during the State of the Union address in early February. I'm not going to play politics here, but Warren Buffett then came out in defense of the capital allocation decision of repurchasing shares of company stock.

I thought now would be an opportune time to look at this area – and, of course, there is an ETF for it.

According to the issuer, the Invesco BuyBack Achievers ETF ( PKW ) tracks the performance of companies that meet the requirements to be classified as BuyBack Achievers. The Nasdaq US BuyBack Achievers Index is comprised of U.S. securities issued by corporations that have effected a net reduction in shares outstanding of 5% or more in the trailing 12 months. The fund and the Index are reconstituted annually in January and rebalanced quarterly in January, April, July, and October.

PKW has outperformed the broad market since last summer. Let’s figure out why that is the case and if now is a good time to put money to work in this equity market factor.

PKW Beating SPX Since Q3 Last Year

PKW is allocated most to the aggressive Consumer Discretionary sector at 23% as of Feb. 27. But you also will find some value positions here with more than 20% of the fund in Financials and a relatively high 10% weight in Energy. Just 8% of the ETF is in the high-growth, long-duration Information Technology sector. So, there’s a bit more value in PKW compared to the S&P 500.

PKW: Sector Allocation Tilted to Value

And that's borne out in the Morningstar x-ray of the product. The Buyback Achievers ETF falls in the “mid-cap blend” quadrant of the Style Box, and the Growth-Value factor is heavily skewed to Value while the total yield is high when combining the dividend and repurchase rates.

PKW is indeed a good value as it trades under 12x earnings while the long-term EPS growth rate is near 14%, per Morningstar. Including this factor into the domestic piece of your equity portfolio looks good.

PKW: Portfolio & Factor Profiles

As for the chart, PKW shows mixed features. While I like that the ETF has undergone a bearish to bullish reversal, breaking through a key downtrend resistance line, the rally is actually a bearish ascending wedge if we are going to be technical – and it’s right at trendline support now. Long here with a tight stop under the 200-day moving average and December low looks like a decent play.

PKW: Bearish to Bullish Reversal Countered With A Bearish Rising Wedge

The Bottom Line

I see February has just a correction in the broader trend higher off the October lows for stocks. While the S&P 500 still trades richly near 18 times forward earnings, compelling valuations in small caps and among international equities, along with positive season trends (it being the third year of an election cycle), and dismal sentiment, should support the market as we progress through 2023.

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