An historical market study and a relative strength indicator both suggest new highs are still in front of us
***Closed for Thanksgiving
As mentioned yesterday, please note that our offices will be closed tomorrow and Friday so that we can spend time with loved ones for Thanksgiving. We’ll take a day off from the Digest tomorrow but will pick back up with it Friday.
From all of us here at InvestorPlace, we wish a Happy Thanksgiving to you and yours!
***Let’s test your investment chops …
As of this past Friday, the S&P had hit 11 new highs in November alone (and we’re setting another record high as I write Wednesday morning). That averaged out to more than one new high every other trading day.
Historically, is such a cluster of new highs an indication of a “blow off” top? Basically, are these highs the fireworks surrounding the end of this historic bull market, and we should expect a correction over the next 12 months?
Or is this cluster of new highs an indication of market strength, and we should look for additional gains over the next year?
The team at Bespoke Investment Group looked into this question and has the answer …
More gains are coming.
At least that’s what historical market data suggests will happen.
According to the Bespoke study, when the stock market has more than 10 new highs over the prior 20 trading days (and there were no prior occurrences of this dynamic in the prior 12 months), prices are likely to push higher over the next three, six, and 12 months.
From Bespoke:
Since 1945, 13 prior periods fit these criteria.
In the three months that followed the prior thirteen occurrences, the S&P 500 saw an average gain of 2.7% (median: 3.3%) with gains 85% of the time.
Six months later, the S&P 500 averaged a gain of 5.9% (median: 6.9%) with gains in all but two periods.
Finally, one year later, the S&P 500 saw an average gain of 8.1% (median: 10.7%) with gains 77% of the time.
Now, you probably noticed that the average gains all came in below the median gains, referenced in the parentheses. On that note, here’s Bespoke:
While the forward returns didn’t necessarily blow the doors off relative to historical averages … more often than not these types of moves didn’t typically presage a market top or major downside reversal.
So, it’s less about predicting huge gains at this point, and more so about predicting a lack of huge losses.
(That said, an average gain of 8% over the next 12 months? I think most of us would take that.)
***But if buying at the top makes you nervous, here’s another indication that the market still has juice in it
This indicator involves something you might have heard about recently in the financial media …
“Value stocks.”
Now, to help explain what’s going on here, I’m going to turn to John Jagerson and Wade Hansen of Strategic Trader. John and Wade are our technical analysts/quant traders. In other words, they heavily rely on charts, numbers, and historical market studies for their investment approach.
Here’s John and Wade to establish some context:
If you’ve ever sat through a 401(k) benefits meeting at work or met with a financial advisor, you’ve likely heard of growth and value stocks … Diversifying between these two stock styles will give you a stronger, more balanced portfolio …
Growth stocks tend to outperform value stocks when the stock market starts to rebound. This happens because traders tend to sell — and take profits on — the conservative value stocks in their portfolio as they become more confident. They then take that money and put it into flashier, more aggressive growth stocks.
Value stocks, on the other hand, tend to outperform growth stocks when the stock market pulls back. This happens because traders tend to sell — and take profits on — the aggressive growth stocks in their portfolio as they become more nervous. They then take that money and put it into cheaper, more conservative value stocks …
John and Wade go on to explain that by comparing growth and value stocks, we can see whether Wall Street is expecting the stock market to rise or is preparing for a potential pullback.
When growth stocks are in favor, we can be increasingly confident that traders believe the stock market is likely to do well.
When value stocks are in favor, we can be increasingly confident that traders believe the stock market is likely to do poorly.
***In recent weeks, the financial media have been reporting on the comeback of value stocks
As of last week, the S&P 500 Value index had climbed 11% over the past three months. That’s more than double the gains of its growth counterpart.
Even more notably, the value index had overtaken the growth index for 2019. Plus, it’s on pace for its strongest year since 2013.
In the chart below, you can see growth beating out value throughout much of 2019, until very recently.
Now, you’re likely scratching your head, thinking “but wait, this would be a bad sign. Value trumping growth would indicate traders are nervous about the market falling.”
You’d be correct. But here’s John and Wade for the quick takeaway:
Value stocks have been flashing warning signs for the past two months. Turns out it was just a false alarm.
***Why the surge in value stocks doesn’t indicate a troubled market
As we noted above, the performance of “growth” versus “value” is often an effective indicator of market direction. So, what’s the easiest way to compare them?
Back to John and Wade:
You can easily compare the performance of these two stock styles by creating a relative-strength chart comparing two exchange-traded funds (ETFs). In this case, the Vanguard Growth ETF (VUG) is the first ETF in the pairing, and the Vanguard Value ETF (VTV) is the second.
When the VUG/VTV relative-strength chart is moving higher, it tells you that VUG is outperforming VTV and the S&P 500 is likely doing well.
Conversely, when the VUG/VTV relative-strength chart is moving lower, it tells you that VUG is underperforming VTV and the S&P 500 is likely feeling some bearish pressure.
The guys tell us that the VUG/VTV chart often diverges from the S&P 500 chart before major trend changes. And we were beginning to see this divergence recently.
The VUG/VTV relative-strength chart had been trending lower while the SPX was (and is) breaking to new all-time highs.
This was a warning sign, mirroring the financial media reports about the rebirth of value investing.
But let’s turn back to John and Wade now:
Luckily for the bulls on Wall Street, that warning sign turned out to be a false alarm.
If you look at the closer view of the VUG/VTV relative-strength chart in Fig. 2, you will see that the chart just completed a bullish “wedge” continuation pattern by breaking up through the down-trending resistance level that started forming in late August.
This tells us that growth stocks are taking the lead once again and are starting to outperform value stocks.
Seeing this gives us confidence the bullish trend in stocks is likely to continue well into the holiday season.
For more from John and Wade, click here.
***This isn’t the first time a value rally has fizzled out
Despite occasional spurts, value has significantly underperformed growth over this decadelong bull.
To illustrate, the S&P 500 value index has climbed 142% over the past 10 years. Compare that to 230% for large growth companies. If the Bespoke study at the top of this Digest is any indication, expect growth to continue its dominance as we head into 2020.
As we wrap up, if you’re looking for clues about market direction, this recent cluster of market highs and the relative strength of VUG/VTV suggest more gains are on the way.
Have a wonderful Thanksgiving tomorrow,
Jeff Remsburg
