Sectors Showing Some Divergence…

So far, U.S. sector directional price trends are showing some divergence in 2015.

Rather than all things rising, such divergence may give hints to new return drivers unfolding as well as opportunity for directional trend systems to create some asymmetry by avoiding the trends I don’t want and get exposure to those I do.

Sector ETF Divergence 2015-03-04_11-24-54

For more information about ASYMMETRY®, visit: http://www.asymmetrymanagedaccounts.com/global-tactical/

 

Chart source: http://www.finviz.com/groups.ashx

 

 

Small vs. Large Stocks: A Tale of Two Markets (Continued)

A quick follow up to my recent comments about the down trend in smaller company stocks in Playing with Relative Strength and Stock Market Peak? A Tale of Two Markets below is a chart and a few observations:

Rusell 2000 Small Caps vs S&P 500 large caps

Source: Bloomberg/KCG

A few observations of the trend direction, momentum, and relative strength.

  • The S&P 500 index (the orange line) of large company stocks has been  in a rising trend of higher highs and higher lows (though that will not continue forever).
  • The white line is the Russell 2000 small company index has been in a downtrend of lower highs and lower lows, though just recently you may observe in the price chart that it is at least slightly higher than its August high. But it remains below the prior two peaks over the past year. From the time frame in the chart, we could also consider it a “non-trending” and volatile period, but its the lower highs make it a downtrend.
  • The green chart at the bottom shows the relative strength between S&P 500 index of large company stocks and the Russell 2000 small company index. Clearly, it hasn’t taken all year to figure out which was trending up and the stronger trend.
  • Such periods take different tactical trading skills to be able to shift profitability. When markets get choppy, you find out who really knows what they’re doing and has an edge. I shared this changing trend back in May in Stock Market Peak? A Tale of Two Markets.

If you are unsure about the relevance of the big picture regarding these things, read Playing with Relative Strength and Stock Market Trend: reverse back down or continuation? and Stock Market Peak? A Tale of Two Markets.

 

Stock Market Trend: reverse back down or continuation?

I normally don’t comment here on my daily observations of very short-term directional trends, though as a fund manager I’m monitoring them every day. The current bull market in stocks is aged, it’s lasted much longer than normal, and it’s been largely driven by actions of the Fed. I can say the same for the upward trend in bond prices. As the Fed has kept interest rates low, that’s kept bond prices higher.

Some day all of that will end.

But that’s the big picture. We may be witnessing the peaking process now, but it may take months for it all to play out. The only thing for certain is that we will only know after it has happened. Until then, we can only assess the probabilities. Some of us have been, and will be, much better at identifying the trend changes early than others.

With that said, I thought I would share my observations of the very short-term directional trends in the stock market since I’ve had several inquiring about it.

First, the large company stock index, the S&P 500, is now at a point where it likely stalls for maybe a few days before it either continues to trend up or it reverses back down. In “Today Was the Kind of Panic Selling I Was Looking For” I pointed out that the magnitude of selling that day may be enough panic selling to put in at least a short-term low. In other words, prices may have fallen down enough to bring in some buying interest. As we can see in the chart below, that was the case: the day I wrote that was the low point in October so far. We’ve since seen a few positive days in the stock index.

stock index 2014-10-22_15-06-14

All charts in this article are courtesy of http://www.stockcharts.com and created by Mike Shell

Larger declines don’t trend straight down. Instead, large declines move down maybe -10%, then go up 5%, then they go down another -10%, and then back up 7%, etc. That’s what makes tactical trading very challenging and it’s what causes most tactical traders to create poor results. Only the most experienced and skilled tactical decision makers know this. Today there are many more people trying to make tactical decisions to manage risk and capture profits, so they’ll figure this out the hard way. There isn’t a perfect ON/OFF switch, it instead requires assessing the probabilities, trends, and controlling risk.

Right now, the index above is at the point, statistically, that it will either stall for maybe a few days before it either continues to trend up or it reverses back down. As it all unfolds over time, my observations and understanding of the “current trend” will evolve based on the price action. If it consolidates by moving up and down a little for a few days and then drifts back up sharply one day, it is likely to continue up and may eventually make a new high. If it reversed down sharply from here, it will likely decline to at least the price low of last week. If it does drift back to last weeks low, it will be at another big crossroads. It may reverse up again, or it may trend down. Either way, if it does decline below low of last week, I think we’ll probably see even lower prices in the weeks and months ahead.

Though I wouldn’t be surprised if the stock index does make a new high in the coming months, one of my empirical observations that I think is most concerning about the stage of the general direction of the stock market is that small company stocks are already in a downtrend. Below is a chart of the Russell 2000 Small Cap Stock Index over the same time frame as the S&P 500 Large Cap Stock Index above. Clearly, smaller companies have already made a lower low and lower highs. That’s a downtrend.

small company stocks 2014 bear market

Smaller company stocks usually lead in the early stage of bear markets. There is a basic economic explanation for why that may be. In the early stage of an economic expansion when the economy is growing strong, it makes sense that smaller companies realize it first. The new business growth probably impacts them in a more quickly and noticeable way. When things slow down, they may also be the first to notice the decline in their earnings and income. I’m not saying that economic growth is the only direct driver of price trends, it isn’t, but price trends unfold the same way. As stocks become full valued at the end of a bull market, skilled investors begin to sell them or stop investing their cash in those same stocks. Smaller companies tend to be the first. That isn’t always the case, but you can see in the chart below, it was so during the early states of the stock market peak in 2007 as prices drifted down into mid 2008. Below is a comparison of the two indexes above. The blue line is the small stock index. In October 2007, it didn’t exceed its prior high in June. Instead, it started drifting down into a series of lower lows and lower highs. It did that as the S&P 500 stock index did make a prior high.

small stocks fall first in bear market

But as you see, both indexes eventually trended down together.

As a reminder to those who may have forgotten, I drew the chart below to show how both of these indexes eventually went on to lower lows and lower highs all the way down to losses greater than -50%. I’m not suggesting that will happen again (though it could) but instead I am pointing out how these things look in the early stages of their decline.

2008 bear market

If you don’t have a real track record evidencing your own skill and experience dealing with these things, right now is a great time to get in touch. By “real”, I’m talking about an actual performance history, not a model, hypothetical, or backtest. I’m not going to be telling you how I’m trading on this website. The only people who will experience that are our investors.

 

 

Playing with Relative Strength

I discussed in my interview with Investor’s Business Daily in 2011 titled “How Mike Shell Uses Relative Strength To Trade ETFs” some very basic concepts of how I apply proprietary relative strength systems to ETFs in a tactical ETF managed portfolio. Though we can develop all kinds of sophisticated algorithms to define relative strength, momentum, and directional price trends, at the end of the day the concept is very simple.

Up until now (a signal that something has changed) small company stocks where lagging large company stocks. To illustrate what that looked like, I stopped the relative chart below in Mid-May. You may observe that the blue line (the Russell 2000 index of small company stocks) was lagging and with a higher range of swings (more volatile). The black line is the S&P 500 stock index weighted toward larger stocks.

small company stocks lagging large

Source: http://www.stockcharts.com

Next we update the chart to today’s date. Over the past month, small companies caught up. However, they are now at the prior high, so we’ll find out in the weeks ahead if the relative out-performance continues, or if it finds some resistance and reverses back down.

small cap stocks relative strength to large company stocks

Below I have zeroed out one side to express only the relative change of the small cap index while holding the large cap index steady. Here we see only the relative difference between small and large over the past year.

relative strength of small vs large ETFs

You can probably see how relative strength isn’t just about strength, there is also relative weakness. And, relative change oscillates over time.

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