RRG Indicates That non-Mega Cap Technology Stocks Are Improving

KEY

TAKEAWAYS

  • The Energy Sector Remains On a Very Strong Rotational Path
  • Completed Top Formation In Healthcare Opens Up Significant Downside Risk
  • Smaller Technology Stocks Are Taking Over From Mega-Cap Names

A Sector Rotation Summary

A quick assessment of current sector rotation on the weekly Relative Rotation Graph:

XLB: Still on a strong trajectory inside the improving quadrant and heading for leading. The upward break of overhead resistance on the price chart seems to be stalling at the moment, which could cause its relative strength compared to the S&P 500 to slow down. Overall, the trend, both in terms of price and relative, is still up.

XLC: Continues to lose relative strength and momentum inside the weakening quadrant and rotates toward lagging at a negative RRG-Heading. On the price chart, XLC is battling resistance, which causes its relative performance to slow down.

XLE: Is at the strongest rotation in this universe. Well inside the improving quadrant at the highest RS-Momentum reading and powered by the longest tail in the universe. The upward break in the price chart is holding up well, and the sector can even handle a small setback towards the former resistance area (just below ~95) without harming its uptrend.

XLF: Was on its way back to the leading quadrant after curling back up inside weakening, but this week’s dip is causing the tail to deviate from that path. This means we must watch this sector closely going into the close of this week and the beginning of next week to see if this is a temporary hiccup or a real change of direction. The nasty dip on the price chart pushes XLF back below its former resistance levels, which is usually not a strong sign. Caution!!

XLI: This is the only sector inside the leading quadrant at the moment, traveling at a strong RRG-Heading, taking the sector higher on both axes. The rally in the price chart is fully intact but seems to stall at current levels for three to four weeks. Plenty of room on the chart for a corrective move in this sector without damaging the uptrend.

XLK: The slow performance, primarily sideways, of the sector since the end of January has caused relative strength to flatten and for the sector to roll over and rotate into the weakening quadrant on the RRG. The jump today (Thursday, 4/11) caused an uptick in relative strength, but much more is needed to bring this sector back to the forefront.

XLP: Did not make it all the way up to horizontal resistance around 77.50 but set a lower high after a nasty reversal last week. The raw RS-Line continues steadily lower, causing the tail on the RRG to remain short and on the left-hand side of the graph, indicating a steady relative downtrend.

XLRE: After a rally at the end of last year, XLRE ended up in a sideways pattern that could turn out to be a double top after that rally. Such a top will be confirmed on a break below 37, which is the lowest low that was set in the week starting 2/12. When that happens, a decline all the way back to the late 2023 low becomes possible. The relative trend reversed back down after a very brief stint through the leading quadrant at the end of January.

XLU: Just moved into the improving quadrant from lagging but remains at a very low RS-Ratio level. The raw RS-Line continues to show a steady downtrend, making it hard for the tail to make it all the way to the leading quadrant. Price managed to break above a falling resistance line but shortly thereafter stalled in the area of Sept-23, Dec-23, and Jan-24 highs. Pressure remains in both price and relative terms.

XLV: After a short rotation through the improving quadrant that lasted roughly two months, XLV has now returned to the lagging quadrant and is pushing deeper into it on a negative RRG-Heading. On the price chart, XLV completed a (double) top formation and broke back below its former overhead resistance level, opening significant downside risk.

XLY: Is hesitating in a sideways pattern since mid-February, but still in a very shallow, uptrend. Relative strength continued to decline but is now nearing its late 2022 relative low, and the RRG-Lines are showing early signs of improvement.

Cap-weighted vs Equal-weighted

The RRG above shows the relative rotation of the relationships between the cap-weighted sector ETFs and their equal-weighted counterparts.

The more interesting information is coming from the tails that are far away from the benchmark. In this case, these are the Communication services sector, which is rolling over inside the leading quadrant, and Consumer Discretionary, which has just turned up inside the lagging quadrant.

This indicates that the large(er) cap communication services stocks are now starting to underperform the lower-tier market capitalizations. The opposite is true for Consumer Discretionary, where the opposite is happening, and larger market cap stocks are taking over from lower tier market caps.

A similar observation can be made for the Technology sector which is heading straight into the lagging quadrant, which suggests that large-cap tech is giving way to smaller names.

This information will be helpful when looking at RRGs for individual stocks inside the sectors.

#StayAlert: –Julius


Julius de Kempenaer
Senior Technical Analyst, StockCharts.com
CreatorRelative Rotation Graphs
FounderRRG Research
Host ofSector Spotlight

Please find my handles for social media channels under the Bio below.

Feedback, comments or questions are welcome at [email protected]. I cannot promise to respond to each and every message, but I will certainly read them and, where reasonably possible, use the feedback and comments or answer questions.

To discuss RRG with me on S.C.A.N., tag me using the handle Julius_RRG.

RRG, Relative Rotation Graphs, JdK RS-Ratio, and JdK RS-Momentum are registered trademarks of RRG Research.

Julius de Kempenaer

About the author:
Julius de Kempenaer is the creator of Relative Rotation Graphs™. This unique method to visualize relative strength within a universe of securities was first launched on Bloomberg professional services terminals in January of 2011 and was released on StockCharts.com in July of 2014.

After graduating from the Dutch Royal Military Academy, Julius served in the Dutch Air Force in multiple officer ranks. He retired from the military as a captain in 1990 to enter the financial industry as a portfolio manager for Equity & Law (now part of AXA Investment Managers).
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You Need To Understand NOW What Changed After The Fed Announcement

I’ve always liked to look at certain points during a bull market or bear market where the character of the market could change based on key fundamental news. We were at one of those points on Wednesday as 2 o’clock approached. The Fed was about to deliver their latest policy statement and traders were on pins and needles. Questions were swirling about what the Fed might say, and do, given the February Core CPI and Core PPI numbers that were reported higher than expected. The Fed already has squashed the bulls once recently, when they shot down the possibility of a March 2024 rate cut after expectations were building for exactly that. There were still the 3 rate cuts supposed to occur in 2024, but the Fed told us that higher rates would remain a bit longer.

Most traders are not blessed with great patience. Things could have turned ugly this past Wednesday at 2pm ET if the Fed decided to wait even longer to lower rates, possibly cutting the expected number of rate cuts from 3 down to some lower number. And what might happen if the Fed did an “about face” and said something that might indicate they’d have to reconsider hiking again? After all, this Fed hasn’t exactly been consistent in its discussion about interest rates.

Well, a lot of that anxiety came to an end on Wednesday as the Fed stuck to its previous guidance, despite the higher inflation reports the week prior. The stock market NEVER performs well when uncertainty is rising, but it generally does quite well when that anxiety is diminished. So at the moment the Fed indicated that nothing had really changed in their view, the stock market screamed higher, with the small cap IWM quickly testing overhead price resistance:

This was the chart I sent to EB members in my Daily Market Report on Thursday. Small caps received the news it was looking for and reacted according – to the upside. But the closing breakout never occurred on Thursday and that false breakout led to some profit taking on Friday. It’ll be interesting to see where small caps head this week. Since 1987, the annualized return for the IWM over the next 7 days is 41.20%, more than 4 times its average annual return. This tells us that history suggests a strong week ahead for small caps. But nothing is more important than the combination of price and volume. Before we grow overly excited about IWM’s prospects, we need to clear candle body price resistance, currently at 208.21.

Major Index and Sector Rotation

With this new information (basically the same as the old), and with inflation fears subsiding further, where did the money go from Wednesday 2pm ET through Friday’s close? Shouldn’t we be interested in what the big Wall Street firms were doing with their money after this fundamental announcement? Well, this is what the big boys were favoring after the announcement.

Major Indices

  • NASDAQ 100 (QQQ): +1.74%
  • Russell 2000 (IWM): +1.73%
  • S&P 400 Mid Cap (MDY): +1.55%
  • S&P 500 Large Cap (SPY): +1.11%
  • Dow Jones (DIA): +0.92%

Sectors

  • Industrials (XLI): +1.49%
  • Communication Services (XLC): +1.46%
  • Technology (XLK): +1.34%
  • Consumer Discretionary (XLY): +0.84%
  • Energy (XLE): +0.74%
  • Financials (XLF): +0.73%
  • Health Care (XLV): +0.48%
  • Materials (XLB): +0.42%
  • Real Estate (XLRE): +0.16%
  • Utilities (XLU): +0.05%
  • Consumer Staples: -0.08%

Clearly, money rotated and benefited “risk on” areas of the stock market, which is secular bull market behavior. Aggressive sectors led by a wide margin over defensive sectors. Money also returned to growth as most growth vs. value ratios turned higher after Wednesday 2pm ET as well.

Industry Group Rotation

We now know that money rotated in bullish fashion and to more growth-oriented areas, though industrials’ leadership and the S&P 500’s break to yet another all-time high after the Fed announcement is further evidence of wide participation in this latest advance. And with small caps right up there with the NASDAQ 100, all those breadth arguments can be tossed right out of the window.

Here’s what we should take away from industry group performance after the Fed meeting:

  1. Semiconductors ($DJUSSC) was #1 among ALL industry groups – not too shocking
  2. The Top 10 industry group performers belonged to either technology (XLK), consumer discretionary (XLY), or industrials (XLI)
  3. Heavy construction ($DJUSHV) had broken out a few weeks ago and the Fed announcement saw momentum increase significantly within this group
  4. Trucking ($DJUSTK) bounced off 50-day SMA support and is poised to break further into all-time high territory, a very bullish development for transportation stocks ($TRAN) in general
  5. Gold mining ($DJUSPM) and mining ($DJUSMG) both saw bullish initial reactions, but then gave back most of those gains by Friday

Big Loser

In my mind, it’s once again gold ($GOLD). I think many traders believed that falling rates ahead would trigger a drop in the U.S. Dollar (UUP). Not gonna happen. Any weakness in the dollar of late has been triggered by potential erosion by inflation. The Fed essentially said that inflation isn’t a problem, despite the higher CPI and PPI readings recently. Our economy remains quite resilient and unemployment remains low, especially compared to foreign economies. That’s why the UUP is strong. Another breakout in the UUP could be at hand:

I know many keep pointing to the recent breakout in GLD, but I want to OUTPERFORM the S&P 500 and the above chart shows you that, outside of a few short-term pops to the upside (blue-dotted directional lines), the overall RELATIVE performance line is going down, down, down in a very big way. No thank you.

A Rapidly-Improving Heavy Construction Small Cap Stock

I was focusing on the heavy construction area ($DJUSHV) this weekend, because of its recent strength and then the surge after last Wednesday’s Fed meeting and policy statement. There are a number of stocks that caught my attention, but one in particular that I believe has a LOT more upside given its current technical outlook. I’ll be sending it out to our FREE EB Digest subscriber community before the market opens tomorrow morning. If you’re not already a subscriber, you can CLICK HERE to sign up with your name and email address. There is no credit card required and you may unsubscribe at any time!

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The Hoax of Modern Finance – Part 11: Valuations, Returns, and Distributions

Note to the reader: This is the eleventh in a series of articles I’m publishing here taken from my book, “Investing with the Trend.” Hopefully, you will find this content useful. Market myths are generally perpetuated by repetition, misleading symbolic connections, and the complete ignorance of facts. The world of finance is full of such tendencies, and here, you’ll see some examples. Please keep in mind that not all of these examples are totally misleading — they are sometimes valid — but have too many holes in them to be worthwhile as investment concepts. And not all are directly related to investing and finance. Enjoy! – Greg


Market Valuations

Because secular markets are defined by long-term swings in valuations, let’s look at the Price Earnings (PE) ratio and study its history. Robert Shiller created a valuable measure of PE valuation that uses trailing (actual) earnings, averaged over a 10-year period. Here’s how it is calculated:

  • Use the yearly earning of the S&P 500 for each of the past 10 years.
  • Adjust these earnings for inflation, using the CPI (i.e. quote each earnings figure in current dollars).
  • Average these values (i.e., add them up and divide by 10), giving us e10.
  • Take the current Price of the S&P 500 and divide by e10.

Figure 8.1 shows the S&P Composite on a monthly basis adjusted for inflation, back to 1871, with a regression line so you can get a feel (visually) of where the current price is relative to the long-term trend of prices. The lower plot is the Shiller PE10 plot, with peaks and troughs identified with their values. You can see that all prior secular bears ended with PE10 as a single digit (4.8, 5.6, 9.1, and 6.6). The PE10, on March 9, 2009, only got down to 13.3, which is considerably higher than the level reached by all prior secular bear lows. Based on this simple analogy, I think we have yet to see the secular bear low for this cycle. Remember, it does not mean that the prices have to go lower than they did in 2009; it just means the PE10 should drop to single digits. Remember, PE is a ratio of Price over Earnings. To make the ratio smaller, either the price can decline, the earnings can increase, or a combination of both.

As of December 31, 2012, the PE10 is at 21.3. Referencing the small box in the lower left corner shows that this value is in the fifth quintile of all the PE data. Based on this analysis, the market is overvalued.

So when the financial news noise is constantly parading analysts by touting the PE as overvalued or undervalued, you can count on the fact that they are using the forward PE ratio. The forward ratio is the guess of all the earnings analysts. They are rarely correct. Ignore them.

Finally, Figure 8.2 shows the PE10 in 10 percent increments or deciles. It shows the extreme level reached in the late 1990s from the tech bubble, it shows the 1929 peak, and it shows that, as of December 31, 2012, we are at the 82nd percentile of PE10. This puts the PE10 overvalued on a relative basis, and also on an absolute basis, as shown in Figure 8.1. Remember, PE10 used real reported (trailing) earnings, not forward (guess) earnings. As Doug Short says on his website at dshort.com: A more cautionary observation is that when the PE10 has fallen from the top to the second quintile, it has eventually declined to the first quintile and bottomed in single digits. Based on the latest 10-year earnings average, to reach a PE10 in the high single digits would require an S&P 500 price decline below 540. Of course, a happier alternative would be for corporate earnings to continue their strong and prolonged surge. If the 2009 trough was not a PE10 bottom, when would we see it occur? These secular declines have ranged in length from more than 19 years to as few as three. As of December 31, 2012, the decline in valuations was approaching its 13th year.

Secular Bear Valuation

Figure 8.3 shows the Shiller PE10 monthly for all the past secular bear markets since 1900, with the current secular bear (as of 2013) in bold. What is really interesting about this chart is that most of the secular bears began with PE Ratios in the 20 to 30 range and ended with them in the 5 to 10 range. The current secular bear began with a PE in the mid-40s and is now only back down to the level that the previous secular bears began. That could imply that the secular bear that began in 2000 could be a long one. These charts were created using monthly data; if yearly data were used, the concept would be even more pronounced.

Secular Bear Valuation Composite

In Figure 8.4, the current secular bear market valuation is shown in bold, with the other line representing the average of the previous four secular bears. Again, this type of analysis is just an observation and for educational purposes; you cannot make investment decisions from this. Investment decisions come from actionable information and analysis.

Secular Bull Valuation

Figure 8.5 of secular bull market valuations shows that most of them begin with PE ratios in the 5 to 10 (same as where secular bears end) and they end with PE ratios in the 20 to 30 range. The excessive secular bull of 1982 to 2000 reached unbelievable high valuations. I remember everyone saying that this time was different. Wrong!

Secular Bull Valuation Composite

 The secular bull market valuation composite is shown in Figure 8.6. It is the average of all the secular bull markets since 1900. Since we are currently in a secular bear market, the average of the secular bull markets is shown by itself.

Market Sectors

I use the sector definitions provided by Standard & Poor’s, of which there are 10. The other primary source for sector analysis is Dow Jones. Either is fine, I just prefer the S&P structure because I have been using it for so long. Table 8.1 shows the 10 sectors’ annual price performance since 1990, and Table 8.2 shows the relative performance of the total returns. When viewing a table of relative returns as in Table 8.2, keep in mind that each column (year) is completely independent of the preceding year or following year. Also, the relative ranking shows that those in the top part of the column outperformed those in the lower part of the column, independent of whether the returns were positive, negative, or a combination. Another value of this type of table is to show that picking last year’s top performer is not a good strategy. Remember, you cannot retire on relative returns.

This book does not get into the various uses of sectors as investments, but the book would not be complete without the mention of sector rotation and, in particular, how various sectors rotate in and out of favor based on the phase of the business cycle and the economy. A further delineation of sectors is their propensity to fall within the broad categories of offensive and defensive. This means that when the market is performing poorly, the defensive sectors will generally outperform, and when the market is performing well, it is the offensive sectors that are the top performers.

The phases of the economy known as economic expansions and contractions are affected by many events but generally boil down to recessions and periods of expansion. It should be noted, however, that not all contractions end up being recessions. The phases can then be broken down into early cycle, mid-cycle, and late cycle segments of the full cycle. There is a lot of literature available to cover all these details, but the point of this discussion is to show the rotational movement of the various sectors through the economic cycle.

Figure 8.7 is a graphic showing the sectors and where they fall in the cycle. It shows the rotation of sectors during an average economic cycle for the past 67 years and is courtesy of Sam Stovall, chief equity strategist, S&P Capital IQ. Sam wrote one of the best books on sector rotation years ago, Standard & Poor’s Sector Investing: How to Buy the Right Stock in the Right Industry at The Right Time, but is currently out of print as of 2013.

Another excellent study I have seen on the cycles within the phases and what sectors are affected was put out by Fidelity and dated August 23, 2010 (see Table 8.3). It clearly showed that, from 1963 through 2010, the following sectors were strongest during the various phases. In each cycle, the top-performing sectors are shown, with the first being the best of the four and the last being the worst of the top four, which is still the fourth best out of the 10 sectors.

It was interesting to note in this study that during all of the three cycles, Utilities and Healthcare were the two worst-performing of all 10 of the sectors (not shown). They only ranked in the top four during actual recessions. Since recessions are usually identified by the NBER about a year after they begin and sometime not until they have ended, this is not knowledge that you can make investment decisions with.

However, you can use a momentum analysis and always be in the top four sectors and probably do well. Clearly, this is certainly better than buy-and-hold or index investing.

Figure 8.8 shows the S&P 500 in the top plot and my Offensive-Defensive Measure in the lower plot. The concept of the Offensive-Defensive Measure is simple.

The Offensive Components

  • Consumer Discretionary
  • Financials
  • Industrials
  • Information Technology

The Defensive Components

  • Consumer Staples
  • Utilities
  • Healthcare
  • Telecom

You can see that the rally from the left side of the chart to point A (February, 2011) was strong; however, based on the switch from offensive to defensive sectors that occurred at point A, the investors were clearly concerned about the market. While the market traded sideways for months (see top plot), the defensive sectors were clearly in the lead, causing the offense-defense measure to decline. The measure declined significantly, and it wasn’t until point B (July 2011) that the market finally gave up and headed south.

Sector Rotation in 3D

Julius de Kempenaer has created a novel way of visualizing sector-rotation, or, more generally, “market-rotation,” in such a way that the relative position of all elements in a universe (sectors, asset classes, individual equities, etc.) can be analyzed in one single graph instead of having to browse through all possible combinations. This graphical representation is called a Relative Rotation Graph or RRG. As of 2013, Julius is now working together with Trevor Neil to further research and implement the use of RRGs in the investment process of investment companies, funds, and individual investors. More information can be found on their website www.relativerotationgraphs.com.

A Relative Rotation Graph takes two inputs that together combine into an RRG. I’ll use the S&P Sectors for this discussion. The first step is to come up with a measure of relative strength of a sector versus the S&P 500; this is done by taking a ratio between each sector and the S&P 500. Analyzing the slope and pace of these individual RS lines gives a pretty good clue about individual comparisons versus their benchmark. These raw RS lines answer “good” or “bad.” However, they do not answer “how good” or “how bad” or “best” and “worst.” The reason for this is that Raw RS values (sector/benchmark) for the various elements in the universe are like apples and oranges, as they cannot be compared based on their numerical value.

Taking the relative positions of all elements in a universe into account in a uniform way enables “ranking.” This process normalizes the various ratios in such a way that their values can be compared as apples to apples, not only against the benchmark but also against each other. The resulting numerical value is known as the JdK RS-Ratio—the higher the value, the better the relative strength. Additionally, not only the level of the ratio, but also the direction and the pace at which it is moving, affects the outcome. A concept similar to the well-known MACD indicator is used to measure the Rate of Change or Momentum of the JdK RS-Ratio line. Here also, it is important to maintain comparable values so another normalization algorithm is applied to the ROC; this line is known as the JdK RS-Momentum. The RRG now has JdK RS-Ratio for the abscissa (X axis) and the JdK RS-Momentum for the ordinate (Y axis). Graphically, the rotation looks like Figure 8.9.

In Figure 8.10, the sectors that are showing strong relative strength, which is still being pushed higher by strong momentum, will show up in the top-right quadrant. By default, the Rate of Change will start to flatten first, then begin to move down. When that happens, the sector moves into the bottom-right quadrant. Here, we find the sectors that are still showing positive relative strength, but with declining momentum. If this deterioration continues, the sector will move into the bottom-left quadrant. These are the sectors with negative relative strength, which is being pushed farther down by negative momentum. Once again, by default, the JdK RS-Momentum value will start to move up first, which will push the sector into the top-left quadrant. This where relative strength is still weak (i.e. < 100 on the JdK RS-Ratio axis) but its momentum is moving up. Finally, if the strength persists, the sector will be pushed into the top-right quadrant again, completing a full rotation.

The next step is to add the third dimension, time, to the plot to visualize the data on a periodic basis and in fact, somewhat like watching a flip chart or animation in which you can see the movement of each of the sectors around the chart as shown in Figure 8.10.

This technology, in static form, is available on the Bloomberg professional service since January 2011 as a native function (RRG<GO>) where users can set their desired universes, benchmarks, lookback periods, and so on. On their aforementioned website, Julius and Trevor maintain a number of RRGs, static and dynamic (animated rotation), on popular universes like the S&P 500 sectors (GICS I & II). Several professional as well as retail software vendors and websites are working to embed the RRG technology in their products, which should make this unique visualization tool available to a wider audience.

Asset Classes

Asset classes can be analyzed exactly the same as market sectors. The only limitation is that they are not tied as closely to economic cycles as sectors, so it is more difficult to identify those that are offensive or defensive. Table 8.4 shows the price performance of a multitude of asset classes. Remember, this table is only showing the annual performance of each asset for each year since 1990, while Table 8.5 has the asset classes ranked each year numerically. Normally, this type of table is shown with multiple colors, but somewhat difficult in a black-and-white book, so rankings are shown. Again, remember that the rankings only show the relative performance, and each year is totally independent of the preceding or following year.

The Lost Decade

Figure 8.11 shows the S&P 500 Total Return from December 31, 1998, to December 31, 2008. Two huge bear markets and two good bull markets. If you have a strategy that could capture a good portion of those bull markets and avoid a good portion of those bear markets, you would do really well. Buy and hold has lost money over this period.

I get asked all the time, “Are we going to have another bear market?” I answer that I can guarantee you that we will; I just have no idea when it will be. However, we can turn to another group of very bright people from the third-largest economy in the world (as of 2013) and look at their market. Figure 8.12 is the Japanese Nikkei from December 31, 1985, to December 31, 2011, a period of time of 26 years, over a quarter of a century.

Clearly, buy and hold was a devastating investment strategy, and the really bad news is that it still is. Figure 8.13 shows the up and down moves during this period, in which a good trend following strategy could have protected you from horrible devastation.

The percentage moves up are shown above the plot, and the percentage moves down are below the plot. These are the percentage moves for each of the up and downs you see on the chart. There were five cyclical bull moves of greater than 60 percent during this period. There were also five cyclical bear moves of greater than -40 percent. Remember, a 40 percent loss requires a gain of 66 percent just to get back to even. The small box in the lower right edge shows the decline from the market top in late December 1989 (–73.3 percent). A 73 percent decline requires a gain of 285 percent to get back even. Most people won’t live long enough for that to happen.

Finally, please notice that Figure 8.13 covers approximately 30 years of data and that the point on the right end (most recent value) is approximately equal to the starting point back in the mid-1980s; certainly the lost three decades. Buy and Hold is Buy and Hope.

Market Returns

It is always good to see how the markets have performed in the past. With the advent of the internet, globalization, minute-by-minute news, investors have a natural tendency to focus on the short term. Without a knowledge of the long-term performance of the markets, that short-term orientation can cause one to be totally out of touch with the reality that the market does not always go up. The following charts will show annualized returns for the S&P 500 price, total return, and inflation-adjusted total return over various periods. These types of charts are also known as rolling return charts. As an example, using the 10-year annualized rolling return, the data begins in 1928, so the first data point would not be until 1938 and be the 10-year annualized return from 1928 to 1938. The next data point would be for the 10-year period from 1929 to 1939, the third from 1930 to 1940, and so on.

Figure 8.14 shows the 1-year annualized return for the S&P price. It should be obvious that one-year returns are all over the place, oscillating between highs in the 40 percent to 50 percent range, and lows in the -15 percent to -25 percent range. Following Figure 8.14 are the 3-year (Figure 8.15), 5-year (Figure 8.16), 10-year (Figure 8.17), and 20-year (Figure 8.18) charts of annualized returns, with the average for all the data shown in the chart caption. Following the 20-year chart is a further analysis for the 20-year period.

The 10-year return chart now clearly shows up-and-down trends in the data (see Figure 8.17).

The 20-year rolling return chart (Figure 8.18) continues to reduce the short-term volatility in the chart, and the up-and-down trends become clear.

Since I adamantly believe that most investors have about 20 years to really put money away in a serious manner for retirement, the following two charts show returns over 20 years for total return (Figure 8.19) and inflation-adjusted total return (Figure 8.20).

For most analysis, the Price chart is more than adequate. In the world of finance, there is an almost universal demand for the Total Return chart; however, I think that if you are going to insist on Total Return, you should then also insist on Inflation-Adjusted Total Return. Using the three preceding 20-year charts and the averages shown, you can see that the average for Price is 6.97 percent, Total Return is 11.32 percent, and Inflation-Adjusted Total Return is 7.19 percent. What this says is that the effect of including dividends (Total Return) and the effect of Inflation often neutralize each other.

Table 8.6 shows the annualized returns for the S&P 500 for price, total return, and inflation-adjusted total return for the following periods: 1-year, 2-year, 3-year, 5-year, 10-year, and 20-year.

Table 8.7 shows the minimum and maximum returns, along with the range of returns, their mean, median, and variability about their mean (Standard Deviation).

Distribution of Returns

The range of return data is very easy to calculate because it is simply the difference between the largest and the smallest values in a data set. Thus, range, including any outliers, is the actual spread of data. Range equals the difference between highest and lowest observed values. However, a great deal of information is ignored when computing the range, because only the largest and smallest data values are considered. The range value of a data set is greatly influenced by the presence of just one unusually large or small value (outlier). The disadvantage of using range is that it does not measure the spread of most of the values—it only measures the spread between highest and lowest values. As a result, other measures are required in order to give a better picture of the data spread. The monthly returns for the S&P 500 begin with December 1927, so, as of December 2012, there are 1,020 months (85 years) of data.

Additional charts show the distribution of data in various ways using the 20-year annualized returns of the S&P 500 inflation-adjusted total return data for rolling 20-year periods. Twenty-year returns from the S&P 500 with 1,020 months of data would yield 778 data points. Return distributions can be thought of like this: Each bar represents the proportion of the returns that meet a percentage division of the data, mathematical division of the data, or statistical division of the data. The following are definitions of the various distribution methods, as shown in the title of the following figures.

  • Decile. One of 10 groups containing an equal number of the items that make up a frequency distribution. The range of returns is determined by the difference between the minimum and maximum returns in the series, then divided by 10 to create 10 equal groups.
  • Quartile. The calculation is similar to decile (above), but with only four groupings.

(Note: This use of decile and quartile does not follow the standard definition or calculation method often used in statistics.)

  • Standard deviation. A statistical measure of the amount by which a set of values differs from the arithmetical mean, equal to the square root of the mean of the differences’ squares. Figure 8.21 shows the percentage of the data that is included in a standard deviation. You can see that the mean is the peak and that 68.2 percent of the data is within one standard deviation from the mean, and 95.4 percent of the data is within two standard deviations of the mean.
  • Percentage. A proportion stated in terms of one-hundredths that is calculated by multiplying a fraction by 100.

Figure 8.22 shows the 20-year rolling returns using inflation-adjusted total return data distributed by quartiles. From the chart, you can see that 13.24 percent of the returns fall into the first quartile, or lowest 25 percent, of the data, 28.15 percent in the second, 32.90 percent in the third, and 25.71 percent in the fourth quartile or highest 25 percent of the data.

Figure 8.23 shows the same data, but in a decile distribution where each bar represents 10 percent of the number of data items. For example, 8.23 percent of the data fell in the highest 10 percent of the data.

Figure 8.24 shows the distribution of the data based on variance from the mean or standard deviation. You can see that the two middle bars each represent 34.1 percent of the data (68.2 percent total) that is one standard deviation from the mean. As an example, 33.68 percent of the 20-year rolling returns data was within one standard deviation above the mean of all the data. You can also surmise that the two bars on the right represent 50 percent of all the data and 53.86 percent (33.68 + 20.18) of the returns. Oversimplifying this, one then knows that there were more returns greater than the mean. However, there is an asymmetrical distribution between the returns that are outside of one standard deviation from the mean, with the larger percentage to the downside.

Figure 8.25 shows the 20-year rolling returns of the S&P 500 inflation-adjusted total return within percentage ranges. The bar on the left shows all the returns of less than 8 percent, which accounted for more than 50 percent of all returns (51.41 percent), while the bar on the right shows returns of greater than 12 percent, accounted for only 11.31 percent of all returns. The bar in the middle is the range of returns between 8 percent and 12 percent, which accounted for 37.28 percent of all returns. Recall the discussion in Chapter 4 on the deception of average, and once again the average 8 percent to 12 percent return is not average.

When the market starts to decline significantly, it is not the same as when someone yells “fire” in a theater. In a theater, everyone is running for the exits. In a big decline in the market, you can run for the exits, but first you have to find someone to replace you—you must find a buyer. Big difference! This chapter has attempted to stick to what I believe are market facts and essential information you should understand in regard to how markets work and have worked in the past. If one does not know market history, it would be very difficult to keep a focus on what the possibilities are in the future.

This concludes the first section of this book, where I have attempted to show you the many popular beliefs about the market that are used by academia and Wall Street to help sell their products. Part I also wraps up with what I believe to be truisms about the market. Part II has an introductory chapter on technical analysis and is followed by two chapters on extensive research into trend determination and risk/drawdowns.


Thanks for reading this far. I intend to publish one article in this series every week. Can’t wait? The book is for sale here.

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With The Top 10 Picks In The Stock Market DRAFT, EarningsBeats.com Selects…

We’re one day away from “DRAFT Day”! Every quarter, we select the 10 equal-weighted stocks that will comprise our 3 portfolios – Model, Aggressive, and Income. My background is in public accounting as I audited companies in the Washington, DC – Baltimore, MD metropolitan area for two decades. While most of my teaching generally encompasses technical analysis and how I use it, I still haven’t let go of my “roots” on the fundamental side. Earnings matter to me. I believe that management teams should develop a business plan that works to their strengths and limits the impact of their weaknesses. And the BEST management teams execute their plan to perfection, beating their own expectations and those of Wall Street.

In order to take advantage of this clear competitive advantage in management teams, we created our flagship ChartList at StockCharts.com, our Strong Earnings ChartList (SECL). I believe that management performance and integrity is so important that I won’t select ANY company for our 3 portfolios, unless it’s on our SECL. Currently, we have 390 companies on this ChartList. Roughly 7-8% of them will be “drafted” by us tomorrow afternoon during our “Top 10 Stock Picks” live virtual event. It’s completely FREE and you’re welcome to join us and witness the process that I go through to assess the current stock market environment and then select the stocks in the best position to benefit from that environment. CLICK HERE for more information and to register.

Let’s look at 3 companies that MIGHT make sense in our portfolios and that will be given considerable consideration:

Walt Disney Co (DIS)

It looks like the triple bottom on the long-term DIS chart near 80 has held and a new uptrend has begun. For the first time since 2020, DIS has made a successful 20-week EMA test and then gone on to break out to new high. We hadn’t seen this since the 20-week EMA was tested during Sep/Oct/Nov 2020. Check this out:

That bottom panel is worrisome for sure. The broadcasting & entertainment index ($DJUSBC) has been absolutely horrific vs. the S&P 500 for 3 years now. Can DIS perform well in such an awful industry environment? Will the industry group begin to reverse, with DIS providing leadership? That’s a difficult call. What we do know, however, is that DIS just posted excellent quarterly results. Revenues came in at $23.55 billion, slightly ahead of consensus estimates of $23.41 billion. Earnings were quite strong, however, at $1.22 per share. Expectations were set at just $.97.

Is DIS worthy of a first-round draft pick? We’ll talk about that tomorrow.

Meta Platforms (META)

Many of our scouts are saying that META could be the #1 overall draft pick. Hailing from the incredibly bullish internet space ($DJUSNS), which has been second only to semiconductors ($DJUSSC) in terms of best relative performance to the S&P 500 over the past year, META has had an MVP type of season, leading its industry peers. Here’s the current chart:

META is one of 8 stocks on our Model Portfolio last quarter that still resides on our SECL. There’s a good chance it gets selected in back-to-back drafts. Over the past 3 months, META gained 41.63%, only beaten by Palo Alto Networks (PANW), which gained 51.22%. Not too surprisingly, our Model Portfolio racked up a quarterly gain of 21.87%, which CRUSHED the S&P 500’s gain of 10.08%.

Sure, it’s trendy to say that META is overbought, along with most every other key technology or communication services name. But those who only look at the last year’s STRAIGHT UP move like to conveniently ignore the fact that META dropped 75% the year before during the cyclical bear market. Market makers were able to scoop up this All-Star at dirt cheap prices for their wealthy institutional clients. Maybe those institutions can give the #1 draft pick acceptance speech, thanking everyone who panicked during that manipulation-driven selloff.

What about META’s fundamentals? Well, last quarter the company produced revenues of $40.11 billion, easily surpassing its $38.99 estimate. And instead of the widely-expected profit of $4.83, META blew the doors off that number, instead coming in at $5.33. What’s not to like here?

Let’s see if META has its name called first on Tuesday! Or how about the other 7 Model Portfolio returning starters? Could they be re-drafted? What a great problem to have!

AZEK Company (AZEK)

It’s easy to talk about META, AMZN, NVDA, etc., but our scout team needs to look deeper and take a stand on potential high-flyers from time to time. Yes, their floor might not be nearly as high as a company like META, but the potential to the upside can be staggering for smaller-cap companies. AZEK isn’t part of the scorching-hot technology (XLK) or communication services (XLC) sectors. Instead, AZEK is a $6.6 billion company in the industrials (XLI) sector and designs, manufactures, and sells building products for residential, commercial, and industrial markets in North America. Technically, it’s been an exceptional performer over the past few months:

Like META, AZEK is a relative leader in a leading industry group, building materials & fixtures ($DJUSBD), which I always love to see. The DJUSBD is the 8th best-performing industry group over the past year. But AZEK is also a smaller company and we know that small caps have struggled relative to their larger cap counterparts. Still, it’s hard to ignore the numbers posted by AZEK. Their revenues were $240 million vs. their expected $234 million. And earnings doubled expectations, $.10 vs. $.05. Results like this can change the future projection of earnings, especially when guidance is raised. AZEK raised its Q2 revenue guidance significantly from $381.6 million to a range from $407-$413 million. And then what happens if AZEK beats estimates again?

Is the potential here solid enough to result in a Top 10 selection?

We have our work cut out for us tomorrow. I’ll be secluded for the next 24 hours in our EarningsBeats.com “War Room”, deciding where the stock market may go over the next 3 months and which areas and stocks are poised to benefit from it. If you’re interested, you can find out more information about this FREE event and REGISTER here.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The EarningsBeats.com Strategy For Uncovering The New Winners

Earnings and interest rates are always the key drivers to stock market success. There may be other short-term factors that influence price action, but, at the end of the day, rising earnings and interest rates conducive to job and economic growth is what results in secular bull markets.

Organize Your Trading Candidates With ChartLists

While I follow interest rates very closely and consider them when evaluating likely future market direction, it’s really the earnings reports that we follow most closely at EarningsBeats.com. Q4 earnings are not yet complete, but most of the very influential companies in the Dow Jones, S&P 500, and NASDAQ have reported. Our research, including earnings research, is organized into many ChartLists, which I briefly describe below:

  • Strong Earnings (SECL): companies beating both revenue and EPS estimates and meeting other liquidity and performance filters. I view it as a list of companies demonstrating high quality technicals and fundamentals. It’s the ChartList that I trade from most frequently.
  • Strong Future Earnings (SFECL): companies that show excellent relative strength (high SCTR scores) and adequate liquidity that are not already on the SECL. I think of it as a list of excellent companies that simply weren’t able to beat estimates in their prior quarter, but who are trading as though they may do so in the quarter ahead.
  • Strong AD (SADCL): companies showing excellent relative strength (high SCTR scores), adequate liquidity, and rising AD (accumulation/distribution, not advance/decline) lines. The AD lines IGNORES opening gaps and focuses only on price action during the day, with volume being the multiplier. Companies on this ChartList are companies that tend to trade higher into the close, suggesting morning weakness might be bought.
  • Raised Guidance (RGCL): companies that, as the name would suggest, raise guidance – either revenues, EPS, or both. I like management teams that feel confident in their business and raise guidance throughout the quarter.
  • Bullish Trifecta (BTCL): companies that are common to the SECL, SADCL, and RGCL. These companies have produced strong quarterly results, have raised guidance, and show possible accumulation by big Wall Street firms.
  • Earnings AD (EADCL): companies that gain AT LEAST 5% from the opening bell to the closing bell on the day after earnings are reported. I then review every one of these companies and provide my Top 30 – companies that I really want to consider trading in the days and weeks ahead.
  • Short Squeeze (SSCL): companies whose float is heavily shorted. We track those companies with short percentage of float in excess of 20%. High short interest can trigger massive short squeeze rallies.
  • Seasonality (SEASCL): companies that have a history of performing well during certain calendar months.
  • Portfolio ChartLists: every quarter, we provide a list of companies that we “draft” into our 4 portfolios – Model Portfolio, Aggressive Portfolio, Income Portfolio, and Model ETF Portfolio.
  • Relative Strength Industry Groups (RSICL): This is an exclusive ChartList for our annual members that tracks the relative strength of every industry group over the past few years. Trading leading stocks in leading industry groups is how you beat the S&P 500 and this ChartList provides us those leading industry groups.

There are other ChartLists that we create from time to time, but you can see from the above that our research is broad and provides a TON of great information for our members on a regular basis. But before trading anything, it makes sense to evaluate the current state of the market. Is the current rally sustainable?

S&P 500: Is the Current Rally Sustainable?

I say yes. Sure, we’ll have some pullbacks along the way, but right now money is flowing into aggressive areas of the market and that “risk on” environment bodes well for higher prices ahead. Check out this S&P 500 chart with several key “sustainability” ratios in the panels below the S&P 500 price chart:

Is this not obvious? Money continues to POUR INTO aggressive areas. The 6 sustainability ratios above can be summarized as follows:

  • QQQ:SPY – NASDAQ 100 performance vs. S&P 500 performance. The NASDAQ 100 is a much more aggressive index, focusing almost solely on high growth large cap stocks.
  • XLY:XLP – consumer discretionary vs. consumer staples. Two-thirds of our GDP is consumer spending. It just makes sense to see which area of consumer spending, aggressive discretionary vs. defensive staples, Wall Street is favoring. That tells us what the big Wall Street firms are expecting in the months ahead.
  • IWF:IWD – large cap growth vs. large cap value.
  • $DJUSGL:$DJUSVL – another measure of large cap growth vs. large cap value
  • $DJUSGM:$DJUSVM – mid cap growth vs. mid cap value
  • $DJUSGS:$DJUSVS – small cap growth vs. small cap value

Every one of my aggressive vs. defensive ratios is climbing. Personally, I love all the pessimists out there constantly trying to tear apart this bull market. The problem is that many analysts are trying to handpick one or two SECONDARY indicators to determine market direction, which is absolutely wrong in my opinion. We remain extremely bullish if we look at the primary indicator, which is price and volume. Sentiment does a great job of marking market tops and bottoms and my favorite sentiment signal is the equity only put call ratio ($CPCE).

Sentiment Paving The Path To Higher Prices….For Now

Despite the nearly straight-up move that we’ve seen on our major indices since late-October, there is little complacency in the options world. Over the past 11 years, or approximately the duration of this entire secular bull market, the average daily CPCE reading has been in the .60-.65 range. Readings higher than this show an unusually heavy dose of equity put buyers (which coincides with market bottoms or approaching market bottoms), while lower readings suggest an unusually heavy dose of equity call buyers (which coincides with market tops or approaching market tops). While action has been mostly bullish in 2024, the average CPCE reading in 2024 has been .65 – a far cry from the 5-day average readings of .55 and below that typically mark market tops. Check this out:

Those red arrows highlight the very low 5-day CPCE readings and show you where the S&P 500 was at roughly the same time. After reviewing this chart, I’d quickly conclude that this rally may continue until we see options traders start pouring into equity calls. Friday’s CPCE reading was 0.48. If the S&P 500 continues higher through much of next week, it’s possible we could finally get a 5-day CPCE reading below .55 to mark a top. Friday’s 0.48 reading was a good start. Keep an eye on this throughout next week.

What Stocks Are Likely To Lead The Next Market Surge

Well, I believe our Earnings AD ChartList (EADCL) will hold the key. Again, this ChartList comprises 30 names that performed exceptionally well the day after its earnings were released as new fundamental information started to be priced in. I expect many of them to perform very well in the weeks ahead. Most of the companies on this ChartList are leaders among their peers. But others might just be getting started. Let me give you 1 of the 30 stocks featured, and one that might fit this description of just getting started – Allegro Microsystems (ALGM), a $6.1 billion semiconductor company:

ALGM’s relative strength vs. its semiconductors peers has been awful. But is it just starting to reverse higher? The AD line began strengthening a few months ago at the initial bottom and, on Friday, ALGM finally broke above a triple top. Notice that volume that accompanied the post-earnings run. We never have any guarantees of future price direction, but I’d certainly say that ALGM has my attention and is a stock that I’ll be watching as this could be the start of a very powerful advance.

In tomorrow’s EB Digest, our FREE newsletter, I’ll be providing everyone a link to our ENTIRE Earnings AD ChartList. If you’re a StockCharts.com Extra or Pro member, you can download this ChartList right into your SC account. Otherwise, you can view all 30 charts to see which stocks could be our leaders in 2024. If you’re not already a FREE EB Digest subscriber, it’s easy to get started. Simply CLICK HERE and provide us your name and email address and we’ll be happy to send you that Earnings AD ChartList in our Monday EB Digest newsletter. There is no credit card required and you can unsubscribe at any time.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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Your Money And You: This Investment Strategy May Very Well Be Your Best Choice?

Every one of us faces this question as we look to the stock market for a better financial future. Let me first start this article with the understanding that the stock market isn’t your only choice in terms of investing in your future (or your child’s or grandchild’s future). But this article will ONLY focus on the stock market.

Your Choices

There are a number of factors to help you decide which investment strategy is right for you. Your age, investment horizon, and ultimate goals will likely weigh heavily in devising your own personal investment strategy. Beyond that, however, you must consider the level of risk you’re comfortable with. Not all stocks in the stock market are equal-weighted in terms of risk.

Growth Stocks Seeking Capital Appreciation

Stocks dependent on strong earnings and strong future earnings growth might be perfect for anyone willing to take higher risks and have plenty of time (younger age) to recoup losses in the near-term, especially if your strategy will be consistent with additional future investments being made as well as current investments. Growth stocks can generate very strong returns in a favorable environment of low interest rates and strong future earnings, but many do no pay anything out of current earnings (think dividends). As economic conditions change, valuations can drop rapidly with lowered expectations of earnings and growth. You don’t have to look back that far (2022 cyclical bear market) to see how far growth stocks can fall in a very short period of time.

As an example, let’s look at NVIDIA Corp (NVDA), which has gained 236% over the past year, but pays no dividend. It’s been the leading NASDAQ 100 stock, along with six others that have more than doubled over the past year:

  • CRWD: +190.98%
  • META: +181.64%
  • AMD: +157.32%
  • PANW: +140.03%
  • AVGO: +119.94%
  • ZS: +109.56%

As a growth stock investor, it’s these types of gains that make investing fun. But there’s a dark side to this group as well. We only need to look back at the past few years of NVDA performance to understand the roller coaster ride that your growth stock might take your money on:

Right now, I’m sure everyone would have liked to have owned a lot of NVDA. But the same wouldn’t have been said at the end of 2023, when NVDA’s 1-year rate of change (ROC) had fallen close to -60%. Bear markets can be absolutely brutal for growth stocks, because their future earnings growth and earnings growth rates contract with economic activity. And, if that’s the primary factor in growth stock valuations, it’s going to be very painful. Even the 6-month ROC in September 2023 was close to -60%. Imagine that your entire portfolio is situated in growth stocks like NVDA 6 months to a year prior to the start of retirement. Then think about the pain and stress, both emotional and financial, that type of drop would inflict on you. When you consider your strategy, you MUST consider all possibilities, not just the best ones.

Conclusion: Investing in growth stocks should be considered in EVERY portfolio. Even those who have already retired could have a nest egg expected to last another 20 years or more. But you won’t need all of that money in the first year of retirement. A portion of your savings will be needed 10-20 years down the road or longer. This portion could be invested a bit more aggressively as you won’t need this money for many years to come. Historically, growth stocks will typically outperform more conservative investment approaches over periods of 10 years or more. However, determining how much you should invest in growth stocks is based on a number of factors, including age, years to invest, personal risk tolerance, investment purposes, financial goals, etc.

Income Investors Seeking Dividend Yield

This is a more conservative strategy that focuses much more on payments to shareholders out of current earnings and in the form of dividends. These more conservative dividend payers tend to see much more consistency in their earnings picture and much less volatility in their stock price, though there certainly can be exceptions to this general rule. These investment are not usually as highly stressed by shorter-term economic concerns. Utilities and real estate companies quickly come to mind. They are not fully insulated from economic concerns, especially real estate as this group can react to movements in interest rates, but most investors in these two sectors look toward higher income/dividends as a primary reason for investment. To illustrate using a perf chart, let’s compare the price performance of a growth area like technology (XLK) to more income-oriented areas like utilities (XLU) and real estate (XLRE), since the current secular bull market advance began in 2013:

Most technology stocks pay little or no dividend, but you can see that the capital appreciation opportunity is obvious. Many of the big drops in the stock market are felt harder in technology, however. The XLU and XLRE provide much smaller opportunities with capital appreciation as their earnings growth prospects do not fluctuate over the years as wildly as technology companies. But the comparative safety of capital, along with a much, much higher portion of current earnings being paid out by utilities and real estate companies is the preference of many income-oriented investors. Their dividends, many times, compete with an even safer form of investment, U.S. Treasury securities.

Combination of Capital Appreciation and Dividend Yield

For many investors, it’s probably a good bet that owning both capital appreciation and dividend-paying stocks makes a lot of sense. And there are a group of stocks that show significant combinations of both strategies that might appeal to many investors. It doesn’t have to be one or the other. How about the “hybrid” company, one whose dividend yield may be more modest, but the dividend growth rate is strong and fairly sustainable. Here are three stocks that might qualify for this hybrid label:

Proctor & Gamble (PG):

PG is a stock normally thought of as defensive and value-oriented. I’m not sure the chart necessarily agrees with this assessment. Let me start by saying that PG has raised its annual dividend for 68 consecutive years. That’s quite an accomplishment in and of itself, considering the number of secular and cyclical bear markets that PG has endured. And PG hasn’t been a bad grower either. Here’s the price chart:

I’ve changed the chart here to quarterly, since dividends are paid out quarterly. I’ve also lengthened the chart to 30 years, so that you can see the power of capital appreciation AND solid increases in dividends each year. PG has not only raised its dividend for 68 consecutive years, but the AVERAGE increase is 8.6% since 1994. Those dividend payouts have spiked significantly, which tells us that the current dividend payout in 2024 will only continue to increase by a rate that will at least keep up with inflation, if not exceed it. Oh, and then throw in the capital appreciation potential. Nothing is ever a guarantee, but PG has been a very solid investment for a long, long time. If you’re a growth investor, however, the day-to-day movement in PG will likely bore you. Boring isn’t always a bad thing, though, especially when it comes to building financial wealth.

Starbucks, Inc. (SBUX):

SBUX is another long-term solid grower in terms of capital appreciation, but long-term investors might be surprised that its dividend yield is currently 2.43%. The price chart below tells its own story in terms of price appreciation, but check out how quickly the SBUX quarterly dividends have been climbing:

While the SBUX capital appreciation rate has slowed from its earlier years, its ability to generate profits to pay out higher and higher dividends has not. SBUX has an average increase in its annual dividends of 17.76% since the secular bull market began in 2013. In recent years, that average increase has fallen into the high single digits (8-9%), but that’s still a very solid annual increase rate.

Nike, Inc. (NKE):

NKE has been a grower over the years and its annual dividend has increased every year this early this century – through two secular bear markets and 3 cyclical bear markets, which shows the company’s ability to increase shareholder weather – even during the worst of stock market climates. Check out NKE’s capital appreciation over the years:

Despite its underperformance the past couple years, NKE has still been a “10-bagger” over the past 15 years, rising from 10 bucks to 100 over that period. But a rapidly-rising annual dividend, combined with price struggles since 2021, now provides a 1.45% dividend yield. Not only has NKE raised its dividend every year over the past couple decades, but its AVERAGE annual dividend increase has been double digits in all but 2 of those years. During 2009 and 2010, NKE “only” raised its annual dividend 8.7% and 8.0%.

These hybrid stocks do feel an impact from economic activity, but the combination of price appreciation and solid dividends and dividend increases should not be overlooked.

For the past several years, with only minor exceptions (namely, the 2022 cyclical bear market), I’ve suggested sticking with this secular bull market. Betting against these bull markets is a big mistake, in my opinion. The perma-bears just keep digging themselves a deeper and deeper hole. In Monday’s FREE EB Digest article, I’ll provide my argument to derail the most common reason for not investing in the stock market right now. If you’re not already an EBD subscriber and you’d like to see Monday’s FREE article, simply CLICK HERE to register with your name and email address. There’s no credit card required and you may unsubscribe at any time.

Happy trading!

Tom

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Perspective And History Tell Us To Lower Our Expectations For Technology Stocks

No one loves a good bull market more than me. History tells us that we want remain mostly on the side of the bulls. Perma-bears have an awful long-term track record. They’ve called 30 of the last 3 secular bear markets. Honestly, those who cannot ever see anything other than a downtrend ahead should find a new occupation or hobby. Here’s the long-term chart of the S&P 500.

GDP + inflation + innovation = roughly an average 9% annual gain on the S&P 500. Ask yourself a question. How many times have you exited the stock market and wished you had just left your investment alone and untouched? Be honest.

Seriously, how often do perma-bears get it right? Hey, listen, there’s nothing wrong with being bearish from time to time if you’re a shorter-term trader. The stock market moves too far sometimes and rightfully needs to correct. And after years of secular bull market strength, there comes a time when stocks need more than a simple correction and a secular bear market is justified. In my opinion, that’s not now. Talk to me again in 2030. We won’t be in one for a long time as the current 11-year secular bull market rages on. But, even during a secular bull market, the bulls must acknowledge when short-term risks grow and portfolio adjustments should be considered.

I believe now is a good time to lean on perspective and the impact it could have in 2024.

We all know (or should know) that the three aggressive sectors – technology (XLK), consumer discretionary (XLY), and communication services (XLC) – tend to lead most secular bull market advances. But they don’t lead all of them. And there are examples right now that maybe our leaders have led for a bit too long.

The S&P 500 just advanced more than 16% in 41 trading days from October 27th through December 28th. We can use a 41-day rate of change (ROC) to see how often this 16% level is reached or exceeded in this time frame. Check this out:

This type of move typically occurs after a big bear market move lower or after a correction. The 2023 occurrence came on the heels of the July through October correction. These huge gains are not normal and rarely result in similar gains moving forward. We need to pause and allow these gains to be absorbed. Also, election years are weak historically during Q1, which is exactly where we’re situated right now. While I expected a scorching January in 2023 based on a few of my signals, I don’t expect that at all in January 2024. Lows in election years tend to coincide with March.

Currently, the largest sector in the S&P 500 is technology, which represents 28.79% of the benchmark. Discretionary represents 10.84% and communication services totals 8.55%. So these 3 aggressive sectors comprise 48.18%, or nearly half of the benchmark. If these 3 groups simply take a few months to absorb recent gains, we could easily see rotation move into other areas like industrials (XLI), financials (XLF), or health care (XLV). These 3 more value-oriented sectors represent more than 34% of the benchmark. While XLY is in the aggressive sector camp, it actually looks like it could still provide a lift to the S&P 500. More on that below.

Technology (XLK) is clearly the one to watch though as it has the biggest impact on the S&P 500. Currently, from this chart alone, I see significant risks ahead if you’re overweighting technology:

Nothing on this chart looks particularly encouraging for technology. The top part of this chart tells us that technology’s relative momentum was VERY stretched – similar to 2020 – and we know what happened next. It was a lengthy period of average to underperformance vs. the S&P 500.

The middle part of the chart shows that the XLK:$SPX relative strength is at the upper end of its relative uptrend, which makes it difficult to continue outperforming. In fact, it’s probably time to consider weak relative strength ahead. Finally, the bottom panel charts the 52-week relative performance. Money has poured into technology over the past year – again similar to 2018. It wouldn’t be normal for this to continue higher. Once again, this tells me the risk is to the downside and it’s not worth the risk of overweighting technology right now.

I’ll make one last point about the likely relative weakness in technology. Check out this 20-year weekly chart of the XLK:

We’re at the top of the XLK’s 15-year channel, which has been problematic at every point in this channel, with the exception of the after-effects of the pandemic. It just looks like time for a change in leadership for a bit.

So all of this leads me to a big question. If technology underperforms, where should we look for relative strength?

XLY:

The XLY is trading much closer to its lower uptrend line, suggesting strength could easily find its way here.

XLV:

The XLV has been consolidating and, therefore, underperforming the S&P 500 for quite awhile. The recent breakout may be the trigger this group needs to see a lot more money rotating IN.

XLF:

Technically, we don’t usually see this group lead. Given the circumstances of the 2008-2009 financial crisis, the XLF has been a tough place to make money. But I believe the group was undervalued while short-term rates jumped and resulted in an inverted yield curve. 2024 is likely to reverse that condition, which will benefit the net interest margin for banks ($DJUSBK), a significant fundamental tailwind. Should our economy grow in 2024, which I believe it will, it could be a goldilocks scenario for banks – a solid, and perhaps even improving, economy coupled with rising spreads.

It will be very interesting to see how the first quarter of 2024 develops. While I can’t guarantee outperformance or underperformance of any area, I do believe that we can assess risk and make more informed trading/investing decisions.

To become a FREE EB Digest subscriber (no credit card required) and to follow me at EarningsBeats.com, simply CLICK HERE and enter your name and email address. You may unsubscribe at any time.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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#Perspective #History #Expectations #Technology #Stocks

Think Really Hard About Who You Want On Your Team

I’m going to start this article a bit different than all the others I’ve written here at StockCharts.com and talk off topic for a paragraph or two.

I grew up in Maryland, quite close to Washington, DC, and was an avid Washington Redskins and Baltimore Orioles fan. I look back now and feel very fortunate that I was able to follow two sports teams that enjoyed decades of success, though both organizations faltered for many years to follow under less-than-desirable ownership. But during the 1960s, 1970s, and 1980s, these two sports organizations won several championships and constantly competed for more. It started with the owners and the culture they built. They hired the right people to build from the ground up and eventually hired two “on-the field generals” that the entire community could embrace. I know I’m a “homer”, but Earl Weaver (Baltimore Orioles Manager from 1968-1982 and also one other year – 1985) and Joe Gibbs (Washington Redskins Head Coach from 1981-1992 and 2004-2007) were two leaders that I immediately respected. I admired Earl Weaver as one of the pioneers of using analytics in his decision-making and he influenced my career as I’ve become quite the stock market historian over the years. Weaver platooned outfielders, depending on pitching matchups, and was one of the first managers to use late inning relief pitchers to seal victories. I’m a “numbers guy” and always have been and I use similar “historical matchups” in the stock market. The use of analytics just makes perfect sense to me.

Joe Gibbs, to this day, is one of my favorite human beings ever. He’s a man of high character, integrity, faith, and family. He is unquestionably a leader, as evidenced by his NFL coaching career, and later, his NASCAR career. He’s simply a winner. His players would run through brick walls for him. He had conviction and he was innovative. Do you know who started the “one-back” set? Counter trey? During his first year as head coach of the Redskins, he started 0-5 before finishing the season on an 8-3 run. The next season, he won his first Super Bowl. He became the only NFL coach in history to win 3 Super Bowls with 3 different starting quarterbacks. Conviction and innovation matter.

These two sports teams and these two coaches, in particular, were of great inspiration to me. They were perfect examples of how to gain an edge on your competition and how you do things the right way.

When I had the opportunity to join the StockCharts.com “team” nearly two decades ago after ending my public accounting career and founding EarningsBeats.com (formerly Invested Central), I jumped at it. Partnering with StockCharts just felt right and we’ve never looked back. While StockCharts.com offers a great trading & tools platform at various price points, they also place a huge emphasis on research and education, two of our three pillars at EarningsBeats.com. I am mostly a self-taught technician as I like to do my own independent research. But I’ve always been a fan of John Murphy’s work and books. Since John was part of the StockCharts team, this was a perfect match for me and EarningsBeats. From its very beginning, StockCharts has boasted a top-notch ChartSchool, providing FREE education, which I use myself from time to time. I’d encourage you to use it, if you haven’t already. There’s a wealth of information and education for both traders and investors. To some degree, EarningsBeats.com has a similar approach. While we charge for much of our market guidance, research, and education, we also provide plenty of FREE information to investors and traders seeking a better and more secure financial future. My Trading Places blog right here at StockCharts is a perfect example, as are my YouTube shows. We also have a FREE EB Digest at EarningsBeats where I produce an educational chart (and two paragraphs) 3x per week. Be sure to subscribe to that with your name and email address if you haven’t already.

In putting YOUR team, that YOU trust, together, I’d encourage you to start with StockCharts.com. I have worked with many of the contributors here at StockCharts and know many of them personally as well. Collectively, it’s a group with high character and integrity with education as a top priority. They provide a TON of free content and you should take advantage of it. Find those that you trust and employ similar strategies to your own, and build the rest of your team from there. In my mind, that’s where a team should start – those who provide education and do their own independent research. That also means IGNORING those that have an agenda, which I’d estimate is roughly 90% of the folks you’ll see on CNBC. We’ve had three (3!!!!!!!!) market crashes in my lifetime, which now spans more than six decades. How can you explain CNBC parading the same group of people across their channel that continue to provide HORRIBLE forecasts year in and year out? There are those that constantly spew a “CRASH” is coming. During my lifetime, the odds of one occurring is about 1 in 20 years. There’s definitely a core cast of “influencers” on CNBC and who knows what their agenda is. I just TURN IT OFF. It is so easy to be swayed when you hear over and over again how awful the economy is. How the debt level is out of control. How higher interest rates will crush the economy. (By the way, now I’m hearing from some folks how the Fed turning dovish is bearish for stocks, too!) You can’t make this stuff up. I’ve “learned” that when the market goes up and breadth is poor, it’s a signal that there’s little participation and we shouldn’t trust the advance. But when breadth is strong, it’s an extreme that marks a top. In other words, SELL if you ever look at breadth, no matter what it shows. Also, if you haven’t heard, a massive recession is coming. That helps to explain why money has been rotating heavily towards consumer discretionary (XLY) vs. consumer staples (XLP) and is currently at a 2023 high – I’m fluent in sarcasm, by the way:

Through all of my years of learning and research, the one chart that I love, perhaps more than any other, is the XLY:XLP ratio. It just makes perfect common sense, right? If our GDP is two-thirds consumer spending and the stock market is the best leading economic indicator, then wouldn’t following a ratio between the offensive consumer discretionary sector (which would presumably do much better in a strong or strengthening economy) and the defensive consumer staples sector just make absolute perfect sense. Look at the correlation coefficient between the S&P 500 and the XLY:XLP ratio in the bottom panel of the chart above. Strong positive correlation is represented by readings > +0.50 and strong inverse correlation is represented by readings < -0.50. This isn’t an opinion of mine. This is an absolute FACT and you can see it clearly on the chart. The XLY:XLP ratio can help us determine if we should expect a current trend in the S&P 500 to continue. It’s my favorite “sustainability” ratio. So when I hear analysts, or anyone for that matter, talk about an impending recession in 2024, I have to disagree. Sorry, not sorry. It helps me ignore all the worries on CNBC and have CONVICTION in my own beliefs.

Conviction matters.

On Monday, December 18th, at 4:30pm ET, I’ll be hosting an event, “The Stock Market & Interest Rates: What History Tells Us.” This is a chance to finish off 2023 by gaining more knowledge about the relationship between the direction of interest rates and the direction of U.S. stock prices. It’ll be one of the many key factors in 2024 stock market performance, so it’s a topic that everyone should understand now. This is a Members-Only event, but a 30-day FREE trial gets you a seat to the event and an opportunity to kick the tires of EarningsBeats.com.

For more information and to start your FREE 30-day trial, CLICK HERE. (Be sure to scroll to the bottom of the form for sign up)

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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#Hard #Team

How RRG Helps Us Find Pair Trading Opportunities

KEY

TAKEAWAYS

  • DJ Industrials closing in on overhead resistance
  • Weekly RRG showing some strong opposite rotations
  • Identifying two potential pair trading setups (MSFT-MRK & NKE-CAT)

The Dow Jones Industrial Index ($INDU) is reaching overhead resistance between 35.5k and 35.7k, which means that upside potential is now limited. Even if the market manages to break that area, the next resistance level is already around just 37k.

However, the relative rotation graph featuring the rotation for all 30 members of the DJ Industrials Index is showing some potentially very interesting pair trade setups.

DJ Industrials

On the weekly chart above, that overhead resistance area is clearly visible. The previous highs, which define the resistance zone, date back to late 2021 and early 2022, almost two years ago. This makes it a very important resistance zone.

An upward break of that resistance will obviously be a very bullish signal. But the recent rally, coming out of the late October low, has been very steep, and it would not be strange to see some form of consolidation against the aforementioned resistance zone.

With overhead resistance nearby, the near-term risk is now to the downside. Looking at the chart, a setback after a peak against resistance could take the Dow as low as 32.3k. This would still keep $INDU within the boundaries of this year’s trading range.

Opposite Tails on Weekly RRG

The weekly relative rotation graph above shows the rotations for all thirty stocks inside the Dow Jones Industrial Index. With the benchmark index still inside a trading range, some of the opposite rotations that are visible on the graph suggest that a few interesting pair trading opportunities are present.

In order to clean up the RRG and put emphasis on the more interesting rotations, I have taken out the tails with less favorable characteristics.

In order to see if I could get confirmation, I have run the same RRG on the daily time frame.

Given the current rotational patterns, many different pair trading opportunities can be found. I encourage you to do your own research and find out whether you have a particularly strong view of specific stocks or combinations of stocks, positive or negative. Here, I will pick two examples of potential pair trades from the RRGs above and look at the individual charts.

NKE vs. CAT

On the weekly RRG, Nike and Caterpillar’s tails are rotating in opposite directions. NKE is inside the improving quadrant and rapidly heading toward leading. CAT is inside the weakening quadrant and rapidly heading toward lagging. Both tails are at the extremes of the RRG and far away from the benchmark. This indicates a big potential for alpha.

NKE

NKE is nearing resistance between 110 and 115, suggesting that there is limited upside potential left, unless NKE can clear this barrier in the coming weeks. However, as we are looking for pair trades, we need to focus more on the relative strength conditions. And these are clearly picking up for NKE.

The JdK RS-Momentum line is already well above 100 and is dragging the JdK RS-Ratio line higher. When both RRG-lines are moving up at the same time, this causes an RRG heading between 0-90 degrees, which we know is an indication of strength.

CAT

On the price chart, CAT has just bounced off its rising support line. The relative performance, however, is not looking that good. The JDK RS-momentum line already dropped below 100 a few weeks ago and is now rapidly dragging the RS-Ratio line lower. This rapid decline in relative strength suggests a further underperformance for CAT in the next few weeks.

Off-setting the relative strength of NKE against the relative weakness of CAT makes for a potentially interesting pair-trading opportunity.

MSFT vs. MRK

The weekly RRG details for Microsoft and Merck show opposite rotational patterns. MSFT has just completed a rotation from leading through weakening and is now back into leading, making it one of the strongest stocks, if not the strongest, in this universe. The opposite goes for MRK, which rotated from lagging into improving and is now crossing back into the lagging quadrant.

We know that rotations that complete on one side of the graph indicate a new up- or down-leg in an already established up or downtrend.

MSFT

The recent break to new all-time highs is holding up well. It has also caused the raw RS-line to push to new highs where it is also holding. This is a strong combination of facts.

After a brief dip below 100, the JdK RS-Momentum line has now crossed back above that level again, dragging the RS-ratio out of its low just above 100. This causes the tail on the RRG to push back into the leading quadrant at a strong RRG-heading.

The combination of strong relative strength and a break to new highs on the price chart makes Microsoft the best chart in this universe for the time being.

MRK

MRK reached its all-time high in May of this year, but has been in a steady downtrend since then. The price of Merck reached support just above 100 a few weeks ago and is still hovering slightly above that area at the moment. A break lower will very likely accelerate the decline, very likely, toward the next level of support, between 92.50 and 95.

The raw RS line is breaking an important horizontal support level, completing a toppish formation. The RRG lines already picked up on the new downtrend in July. The recent hiccup of the RS-Momentum line above 100 is the result of the sideways consolidation of relative strength above support.

With raw RS breaking support and the RS momentum line dropping below 100, both RRG-Lines are now once again moving lower while below 100. This is causing the tail on the RRG to move deeper into the lagging quadrant while traveling at a negative heading.

Both tails completing a rotation at the same side of the RRG suggests a continuation of the ongoing outperformance of MSFT over MRK.

Enjoy your Thanksgiving weekend, but #StayAlert, –Julius

Julius de Kempenaer
Senior Technical Analyst, StockCharts.com
CreatorRelative Rotation Graphs
FounderRRG Research
Host ofSector Spotlight

Please find my handles for social media channels under the Bio below.

Feedback, comments or questions are welcome at [email protected]. I cannot promise to respond to each and every message, but I will certainly read them and, where reasonably possible, use the feedback and comments or answer questions.

To discuss RRG with me on S.C.A.N., tag me using the handle Julius_RRG.

RRG, Relative Rotation Graphs, JdK RS-Ratio, and JdK RS-Momentum are registered trademarks of RRG Research.

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#RRG #Helps #Find #Pair #Trading #Opportunities

EB Weekly Market Report – Monday, November 20, 2023

Sample Report

Below is our latest Weekly Market Report (WMR), which is published on Sunday/Monday of every trading week. It’s unlike our Daily Market Report (DMR) as the WMR focuses almost exclusively on the Big Picture and is more designed for those with longer-term investing/trading horizons. Our DMR looks much more closely at current action, designed more for active traders.

I thank all of you that have followed my work here at StockCharts.com over the past 16 years and this sample report is just a small Thank You for your support! If you like the report below and would like to subscribe to our full service, we do offer a 30-day FREE trial and signing up now makes a lot of sense. Our Fall Special, which offers the absolute best price for our service, begins tomorrow and will last roughly through the end of November. If you take us up on our Trial Offer and enjoy our service, you can then subscribe using our BEST DEAL of the year.

Either way, ENJOY and Happy Thanksgiving!

Weekly Market Recap

Major Indices

We finally saw some relative strength out of small caps (IWM) and mid caps (MDY) last week. All of our major indices gained ground, but the IWM nearly tripled the NASDAQ 100 and simply acted much more bullishly after the tame October CPI report was released on Tuesday morning before the opening bell. That triggered a tsunami of buying on Tuesday. After a brief pullback, the small cap bulls were back out on Friday. I would treat the IWM as an uptrending ETF – until proven otherwise. Check out the chart, with two key support levels identified:

There’s still much work to do, but the IWM is at least beginning to show significant improvement, especially on the absolute price chart. The huge gap up on Tuesday now provides us excellent gap support at 174.23 and the rising 20-day EMA is currently at 172.17. Those are the two support levels to watch closely.

Sectors

Two sectors that had really struggled in 2023 due to higher interest rates were real estate (XLRE) and utilities (XLU). It made sense for these two to perform well when investors poured into bonds last week, sending the 10-year treasury yield ($TNX) plummeting. Consumer discretionary (XLY) had an excellent week as well. You’ll see below that 4 of the top 6 industry groups last week were in the consumer discretionary sector.

I generally define a daily uptrend as “price above the 20-day EMA and the 20-day EMA above the 50-day SMA”. Of our 11 sectors, XLB is on the verge of meeting this definition as it prepares for a golden cross (20-day EMA crossing above 50-day SMA). The only other two sectors not meeting this definition and still showing more work left on their charts are energy (XLE) and health care (XLV). Here are the two charts:

XLE:

The XLE printed a tail beneath recent price support on Thursday, then recovered to test its nemesis, the 20-day EMA. Currently, the XLE is caught between those two – price support near 82.50 and the 20-day EMA at 85.26. Let’s see which one breaks first. In a bull market, I give the edge to the XLE breaking back above the 20-day EMA.

XLV:

The XLV seems to be a bit further along in its recovery attempt. It currently resides right at key price and trendline resistance. A breakout would be a solid piece of technical evidence that the “correction bottom” is in for the XLV.

Top 10 Industries Last Week

Renewable energy ($DWCREE) jumped about 13% on Tuesday alone after the October CPI report was released. The 290-300 area has proven to be difficult short-term resistance, so let’s see if the group can power through that area this week:

In that resistance zone is gap resistance and multiple price attempts at a breakout, so clearing it would definitely improve the technical picture here, perhaps even switching the overall trend from downtrend to uptrend. Before you get too excited, however, please keep in mind that renewables have been lagging badly vs. the benchmark S&P 500. We’ve seen some improvement, but there’s little leadership. In other words, much of the current rebound can be attributed to very oversold conditions and a bounce, plus a very strong overall market. It’s the old Wall Street adage, “a rising tide lifts all boats”. In that bottom panel, breaking the relative downtrend is truly what this group needs.

Bottom 10 Industries Last Week

I find about half of the above industry groups to be bullish on their charts. Apparel retail ($DJUSRA) has been very strong since its early-June low and the recent selling appears to be a handle off of a cup:

The huge spike in volume likely was the result of Gap’s (GPS) massive volume, which accompanied a much-stronger-than-expected quarterly earnings report. The DJUSIB, DJUSRD, DJUSMF, and DJUSHN all were among the 10 biggest losers last week, but still show technical promise, in my opinion. The DJUSIB, in particular, looks solid, having broken to a 52-week high earlier this month and still trading well above its rising 20-day EMA.

Top 10 Stocks – S&P 500/NASDAQ 100

Bottom 10 Stocks – S&P 500/NASDAQ 100

Big Picture

We cleared yet another hurdle on the S&P 500 as we cleared the 4500 level. After reaching a high of just over 4600 in July and pulling back to 4103.78 on October 27th, the bulls are back in charge. The S&P 500 is now nearing its 2023 high, just 2% away. The recent recovery is just one more reason why I like to take a step back and view the “Big Picture”, much more easily recognizing the current secular bull market:

The bottom panel highlights the 240-month (20 year) rate of change (ROC). I like to look at this for perspective. While many bearish analysts believe we’ve run too far to the upside and have lots of downside ahead, this 240-month ROC tells me a completely different story. This ROC has come nowhere close to the highs we saw in the previous two secular bull markets. If anything, this suggests we could have much more upside ahead than any of us can imagine right now. It’s one reason why I believe the S&P 500 could triple over the next 8-10 years, before we hit the next secular bear market.

Sentiment

I look at two key sentiment readings – the Volatility Index ($VIX) and the equity-only put-call ratio ($CPCE). Others use surveys, but I don’t trust those. After all, wouldn’t you rather see what traders are doing with their money rather than their lips? Yeah, me too.

Volatility Index ($VIX)

The first thing to understand is that the VIX is a calculation of “expected volatility” ahead. The calculation is based on the pricing of short-term S&P options. I like to view this as my “market maker sentiment reading”. Market makers set the premiums that they require option holders to pay. If market makers are looking to protect themselves against volatile market action, they’ll put higher premiums on options. If we’re in a boring market environment (nearly always occurs in bullish market environments), premiums are much lower and indicative of little volatility ahead. Market makers are giving us a GREAT BIG CLUE as to where they see the market heading.

Typically, a VIX over 20 suggests a fairly high expectation of trouble ahead as when the VIX rises above 20, you really want to avoid taking any unnecessary risks on the long side. Instead, you want to hunker down. The higher the VIX level goes, the more volatile and scary the action can get. VIX readings above 30 usually require market capitulation before we get a more tradable market on the long side.

If the VIX is in the 17-20 range, I’m usually on high alert. If it’s falling in this range, it can a very bullish signal. If it’s rising in this range, however, and approaching 20, caution would be suggested as selling could escalate quickly. At this point, if I was long and wanted to stay long, I might consider a covered call strategy, if you’re familiar with options. You’ll get a nice premium and it’s a way to at least hedge a little against your long positions.

The most bullish environment is when the VIX is below 17 and declining. We’ve seen that recently. Here’s where the VIX currently stands:

Check out that first big spike in the VIX back in March. That should be ingrained in your mind. That’s what can happen when the VIX moves through 20 resistance and accelerates. The stock market took a tumble of roughly 250 points in one week. The October scare saw the VIX jump 50% in a couple weeks, clearing 20 and reaching a high just above 23. That coincided with another significant selloff as the S&P 500 again lost about 250 points.

Look at those thick red/blue directional lines in November, though. As the VIX came tumbling down, we had a massive market rally as fear began to dwindle. All of this occurred during what we already knew was THE most bullish period historically of the entire year. This is how we can put puzzle pieces together in the short-term to increase our probability of making great market calls.

Equity-Only Put-Call Ratio ($CPCE)

While the VIX is a market-maker-related sentiment signal, the CPCE tells us what the retail trader is doing with their money. Just keep in mind that when retail option traders all start to pile in on the same side of the trade, it usually ends in very ugly fashion for them. We’re looking for the “rubber band to stretch” significantly in either bullish or bearish fashion and we position ourselves on the opposite side, waiting for the “snap back”. In my experience, any time the 5-day SMA of the CPCE hits .75, extreme fear is building and we should begin looking for a market bottom. Sometimes this 5-day SMA reading can reach as high as .85-.90 before a bottom is reached, so this isn’t an exact science. The main point I’m making is that, if you’re shorting or trading equity puts, you need to understand that your profits could swiftly disintegrate once the 5-day SMA of the CPCE moves past .75.

Here’s a historical chart of the CPCE (5-day SMA) to illustrate how this works:

The low 5-day SMA readings below .54-.56 have been solid signals in marking short-term tops, while high 5-day readings above .75 have been excellent in providing us clues of market bottoms. The last reading was circled in red, because it occurred while the market was accelerating to the upside. This tells me that we still have PLENTY of doubters as we rally. I believe that’s a very bullish signal.

Inflation

On Tuesday morning, the October CPI report was released, followed by the October PPI report on Wednesday morning. Both reports continue to stress that inflation is FALLING and it has been consistently for over a year. The stock market LOVES this news and is now rising to be priced accordingly. Do you believe inflation remains a big problem? Keep in mind that the Fed is most interested in Core CPI, so below you’ll find a chart of the absolute monthly Core CPI numbers with two panels below. The first shows the annual Core CPI (12-month rate of change) and the second panel shows the 1-month rate of change (ROC) of Core CPI:

The annual rate is dropping every single month and is now back to 4%. We’re not at the Fed’s target rate of 2%, but the last four monthly CPI increases have been in the “normal range” for the past 30-40 years, between 0.5% and 0.3%. If inflation remains in this area, we’ll be approaching the Fed’s target inflation level by June 2023, which is when many analysts believe the Fed will start lowering interest rates to spark a slowing economy. It’s interesting how this inflation data lines up almost perfectly with that narrative.

Intermarket Analysis

In addition to following technical price action on our major indices, just like most technical analysts, I believe it’s extremely important to monitor key intermarket relationships as well. The two primary relationships for me are (1) XLY:XLP to watch the rotation between the more aggressive discretionary sector (XLY) and the more defensive staples sector (XLP), and (2) QQQ:SPY to observe the rotation between the more growth-oriented NASDAQ 100 and the more value-oriented S&P 500. The former is extremely important, because our GDP is comprised roughly of two-thirds consumer spending. Watching to see where these consumer dollars are going helps us determine whether investors are in a “risk on” or “risk off” mode. The former is bullish, while the latter is bearish.

So where do these two relationships stand today?

XLY:XLP

My analysis features this relationship “ignoring gaps” and “including gaps”. I believe the stock market is highly manipulated, especially at the opening bell. A gap down is a great way to “encourage” unsuspecting traders to sell and a gap up is a great way to “encourage” those same unsuspecting traders to buy. The top panel ignores that opening bell activity and focuses ONLY on the rotation during the trading day. You can’t plot this on a chart with regular data. In order get this intraday rotation, you must keep a User-Defined Index at StockCharts, which is exactly what I do. What we saw during much of the correction was a weak S&P 500, but a strengthening XLY:XLP. It was a rather important signal that the S&P 500 selling would not last. Now we see the result as our major indices scream higher once again.

QQQ:SPY

While the S&P 500 has yet to break above its July high near 4600, this ratio has broken out whether we include or ignore gaps. Again, it’s a bullish signal as the big Wall Street firms buy into the more aggressive growth index, while simultaneously appearing on CNBC to spread indecision, fear, and sometimes, outright doom and gloom. Follow the charts, not the lips on CNBC.

Trade Setup

I discuss potential trade setups here from a LONG-TERM perspective. These are not trades where you’re hoping to jump in, make 10-15%, then sell and move on to something else. Instead, I focus here on stocks that generally have solid long-term track records. Entering at the current level might make sense due to various factors.

Today, I want to highlight Seagate Technology Holdings (STX) as it has performed better than the S&P 500 over time and it also has performed much better than one of its primary competitors, Western Digital Corp (WDC). I also like the recent technical breakout on STX after languishing mostly during the 2022 cyclical bear market and the recent market correction from July to October:

Another positive with STX is that it pays a healthy $2.80 dividend ($.70 per quarter), which results in a 3.69% dividend yield, not a bad addition to the solid long-term capital appreciation.

Looking Ahead

Upcoming Earnings:

Earnings season is slowing down now and most big companies with calendar quarter ends (March, June, September, and December) have already reported their quarterly results. There are a few, however, that do report in other months and you’ll see below that NVIDIA Corp (NVDA) is one of those. The following earnings reports (market cap in parenthesis) are, in my opinion, at least relatively significant and worth watching. This is NOT a list of ALL companies reporting this week, so please be sure to check for earnings of any companies that you own or add:

  • Monday: A ($33 billion), KEYS ($24 billion), ZM ($19 billion)
  • Tuesday: NVDA ($1.2 trillion), LOW ($117 million), ADI ($90 billion)
  • Wednesday: DE ($109 billion)
  • Thursday: None – Market Closed for Thanksgiving Day Holiday
  • Friday: None – Market Closes Early at 1pm ET

Key Economic Reports:

  • Monday: Leading indicators
  • Tuesday: Existing home sales, FOMC minutes
  • Wednesday: Initial jobless claims, durable goods, consumer sentiment
  • Thursday: None – Market Closed for Thanksgiving Day Holiday
  • Friday: None – Market Closes Early at 1pm ET

Historical Data

I’m a true stock market historian. I am absolutely PASSIONATE about studying stock market history to provide us more clues about likely stock market direction. While I don’t use history as a primary indicator, I’m always very aware of it as a secondary indicator. I love it when history lines up with all my other signals, providing me much more confidence to make particular trades.

Each week, I’ll provide you the average annualized returns for each calendar day and by index. Here are the historical numbers for this week:

S&P 500

  • November 20: -32.39%
  • November 21: +55.64%
  • November 22: -1.21%
  • November 23: +49.61%
  • November 24: +127.98%

NASDAQ

  • November 20: -90.10%
  • November 21: +74.67%
  • November 22: -17.21%
  • November 23: +34.13%
  • November 24: +230.95%

Russell 2000

  • November 20: -72.94%
  • November 21: +71.46%
  • November 22: -9.82%
  • November 23: +63.10%
  • November 24: +255.15%

The S&P 500 data dates back to 1950, while the NASDAQ and Russell 2000 information date back to 1971 and 1987, respectively.

We are now in the most bullish period of the calendar year. The close on October 27th through the close on January 18th is THE ABSOLUTE BEST TIME OF THE YEAR FOR U.S. EQUITIES – HISTORICALLY SPEAKING. Last week was an “ok” period for equities, but the upcoming week typically sees much more historically-bullish action and this bullishness extends through the first week of December.

Final Thoughts

As we move into the Thanksgiving holiday season, let’s keep a few things in mind:

  1. Historical bullishness should not be ignored. 73 years of data on the S&P 500 tell us that NOW is the best time of the calendar year to be bullish and to be long. Fight this historical bullishness at your own risk.
  2. The 10-year treasury yield ($TNX) has lost neckline support in a topping head & shoulders pattern, with its initial measurement pegged near the 4.10% level
  3. Key intermarket relationships point to the sustainability of the current S&P 500 rally; 4600 is the next significant test, with a breakout likely sending us higher to test the all-time high near 4820
  4. NVIDIA Corp (NVDA) reports its earnings on Tuesday after the bell; this will be significant not only for NVDA, but also for the entire semiconductor group ($DJUSSC). I expect big numbers from NVDA, but it has run a lot in November, now testing critical price resistance at 500.
  5. Small caps (IWM) have shown improvement, but continue to watch the KRE (regional banking ETF) and XBI (widely-diversified biotech ETF) for clues about future relative strength; these are the two industry groups that most heavily influence IWM performance.
  6. As I pointed out last week, TG Therapeutics (TGTX) is a strong short squeeze candidate, with over 27% of its float short. The closing breakout level of 11.88 provided was cleared on Friday’s close and we now see the result as TGTX is up more than 5.5% at my last look. Volume is picking up and there’s little overhead price resistance. Shorts could be covering big time later today. Wildly accelerating volume will be the major clue that a significant short squeeze is, in fact, underway. Short squeeze trades are ALWAYS extremely risky, but this one has the potential to fly this week.
  7. I want to wish everyone a very happy Thanksgiving holiday weekend. If you’re traveling to be with friends and family, please be safe!

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Happy trading!

Tom

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