Time For Growth To Outperform Value?

One of the indicators favored by Baseline Analytics is the Growth vs. Value Ratio. This is measured by taking the Russell 2000 Growth Index (RUO) divided by the Russell 2000 Value Index (RUJ). To measure trend, we plot this ratio against its 50-day exponential moving average. See the chart below:

As you will note, the Growth/Value Ratio, denoted by the solid blue line, tends to outperform during uptrends in the S&P500. Conversely, the Growth/Value Ratio underperforms during S&P500 downtrends, as value tends to be favored. Growth stocks tend to outperform during bullish enthusiasm, presiding during the "risk-on" trade.

In April, you can see that the ratio edged above its moving average (very slightly) and appears to be forming a respectable basing pattern. A climbing ratio will be supportive of a continued advance in the market indices. Keep a watch on this activity.

- Baseline Analytics

Are Small Caps Signaling a Warning for the Stock Market?

As veteran investor and money manager Bob Farrell has noted, the market cannot continue to rally with just a few large-caps (generals) leading the way. Small and mid-caps (the troops) must also be on board to give the rally credibility. A rally that lifts all boats indicates far-reaching strength and increases the chances of further gains.

As seen in the chart below, small caps relative performance vs. large caps peaked in May, 2011.  Since then, performance has lagged, and has taken a pointed hit as recently as March, 2013.  Studies have also noted that small-cap firms tend to outperform large-caps over the years subsequent to an economic trough. In the year prior to the business cycle peak, however, small caps tend to lag. This would appear consistent with the slowing down of economic growth after the sharp run-up of GDP following the 2009 trough. The lagging small-caps may be a warning sign that a peak in the economic cycle is emerging.

Also noted in the chart above, there has been a lag of about 2 years between the peak in small-caps and the peak in the S&P500.  If this relationship holds, it would suggest a stock market peak in the relative near-term.

Taking into consideration the slowing economic momentum and the historic technical relative performance of small-caps vs. large-caps, a potential warning sign emerges for the stock market in general. 

- Baseline Analytics

Divergences Build as Indices Reach New Highs

Although traders and investors are taught to treat the "trend" as their "friend," we cannot always wholeheartedly trust that friendship as the trend grows older.

As the markets tangle with new highs, several divergences in market index activity have begun to surface, and investors are cautioned to heed their potential warnings.  This is not an indication to give up on the bull trend, but a subtle suggestion to protect capital and to avoid chasing the rally.

Once such divergence has been the performance of financial stocks as measured by the comparison of XLF to the S&P500.  As the S&P500 has reached a new high, the XLF:SPX ratio has lagged in a consolidating pattern.   Financials have been considered to be an important part in confirming a trend.  Their recent divergence is cause for second-guessing the strength of the rally.

Another divergence that has surfaced is the outperformance of value stocks vs. growth stocks.  In "risk-on" environments supporting stock market rallies, growth tends to outperform value.  Similar to the XLF:SPX relationship, growth vs.value has also begun to churn downward:

Finally, strength in small cap stocks (like growth stocks) are considered indicators of the "risk-on" trade and supportive of market rallies.  Small Caps however peaked most recently in March (lifted from their trough in October) and have corrected rather sharply in the last 3 weeks.  As the chart below also demonstrates, small caps tend to lag the broader market by 18-24 months peak-to-peak.  A similar pattern, if it plays out as it has historically, would suggest rough going for the major indices potentially starting in the next 30-60 day timeframe:

These divergences (and others that have begun to emerge, such as declining peaks in relative strength and the failure of transportation stocks to yet reach a peak as the DOW has), should be considered as a warning for traders and investors to avoid randomly throwing capital at the stock market. This would be an appropriate time to set stops, take a few profits and prepare a buy list for a meaningful pullback.

- Baseline Analytics

Using ADX to Assess the Risk to the Current Trend

ADX (Average Directional Index) measures trend strength regardless of trend direction. Historically, as depicted below, when ADX peaks near 40, a trend change is increasingly likely.

ADX was developed by Welles Wilder for the commodities market, and does show its imperfections when applied to stocks. Typically, a strong trend is present when ADX is trading over 25 and no trend is present when trading at 20 or below. 

As seen above, ADX is pushing toward another intermediate-term peak near 40. At this level, I would be hesitant to embrace new long positions and protect longs with stops. Some selective shorting would also be in order with protective stops.

Consider using ADX in your arsenal of technical analysis tools.  At the very least, today's level of ADX should encourage traders and investors to be cautious of the uptrend, albeit for a short timeframe as the market consolidates its recent gains.

Learn more about our trend change signals at Baseline Analytics TrendFlex.

Introducing Our New Chart List on StockCharts.com

Baseline Analytics introduces a new public chart list on StockCharts.com.  The list includes some of the key market and economic indicators used to calculate the TrendFlex Score.

Visit StockCharts.com and our chart list

Learn more about Baseline Analytics TrendFlex and how to stay on the RIGHT side of the market.

What is VIX saying about today's market?

Market sentiment can be measured in many ways. These include Investor's Intelligence surveys, the Daily Sentiment Index (DSI), as well as readily-available VIX and Put/Call ratio indicators.
Baseline Analytics TrendFlex uses VIX and Put/Call ratios as an indicator to assess the risk of the current trend changing.

For example, see the chart below. The S&P500 is plotted on the main chart with VIX (pink line) behind it, and the Put/Call ratio below. Each indicator is compared to its 34-day exponential moving average. 

You will note the ovals drawn at various points on the VIX chart as well as circles drawn on the Put/Call ratio chart. These indicate extreme points vs. the indicator's 34-day exponential moving average. VIX and Put/Call indicators and their "gap" from the moving average are treated as contrary indicators. In calculating part of its TrendFlex Score, Baseline Analytics treats an extreme high in VIX or Put/Call, considered "extreme fear," as a contrary indicator. This signals a potential bullish trend change. Note the extreme points marked at the start of June 2012. That point effectively signaled a shift in the S&P500 from a downtrend to an uptrend.

Today, VIX remains over 20% below its 50-day exponential moving average and 18% below its 34-day moving average. See the chart below:



Please note that Friday was options expiration day, so that may have skewed the final price. But in the past, such extremes versus these moving averages have been useful technical indicators to suggest caution with the current trend. With VIX being low and suggesting complacency, investors are encouraged to protect long positions with stops, hedge with options or index shorts, and not to wholeheartedly embrace the uptrend by adding aggressively to long positions, afraid to miss the rally.

Although this signal is not 100% effective on its own, traders and investors are encouraged to use this tool alongside other technical indicators to assess the risk of change in the current trend.  Click here to learn more about Baseline Analytics TrendFlex indicators and our TrendFlex Score designed to measure the risk of a trend change.

Dow Theory Affirms Market Uptrend

This past October, the Dow reached a new high but the Transportation index lagged, as seen on the chart below.  This raised suspicions that the uptrend in the Dow (and S&P 500 for that matter), was on soft footing.  Dow Theory looks for consistency in technical patterns between the Dow and the Transportation Index.

When the indices diverge, for example, a vote of non-confidence is given to the Dow trend. When they agree, especially as they stair-step higher, a vote of confidence in the uptrend is affirmed.

In December, the Transportation Index broke out of a consolidating pattern and has head toward a new high. The Dow reached a high in September/October as the chart below shows, and is beginning to challenge that high in January.

For a primary trend buy or sell signal to be valid, both the Industrial Average and the Transportation Index must confirm each other. If one average records a new high or new low, then the other must soon follow for a Dow Theory signal to be considered valid.  See below a depiction of Dow Theory signals from StockCharts.com.

There are some criticism of Dow Theory, such as the fact that the Transportation Index and the Dow Industrials today are comprised of quite different components than the original industrials and railroad stocks. Dow Theory, however, should be used as a part of the market technician's toolkit.

At Baseline Analytics TrendFlex, several indicators like this are scored to determine the risk to the current trend.  Learn more about our indicators and subscribe to our weekly signal updates at Baseline Analytics.

- Baseline Analytics