The following commentary originally appeared at Treasure Chests.info on Friday September 15th 2003.
Constantly looking for various indicators not followed by the mainstream to provide directional indicators in the markets these days. If one were to be utilizing strictly historically significant methodologies these days, I think the conclusions you may be arriving at would paint an inappropriate picture.
Hence, I decided to take a peak at how the ratios some of the various sub-groups and early/late cycle performers were doing, and decided to focus on a study of value vs. growth for today. Interestingly, in searching for non-traditional indications of the markets condition, I ended up right back at the traditional measures we are about to examine. Security selection for the study was slightly challenging, but I decided on the Value Line Arithmetic Growth Index (VLE) and the Fidelity Advisor Growth Opportunities Fund Class (FAGCX) to represent their respective groups, the former being value and the latter growth.
In examining a ratio set run, I selected the best representation I could find to capture both the current conditions and potential future prospects. But, before we examine the ratio pattern/characteristics, I would first like to show you a picture of each category representative in isolation, in order to give you an idea of where we are in their cycles. Lets start with the VLE, as the primary understanding you should come away with after reading this discourse, is the fact that we are not only in a late cycle condition as far as the stock market as a whole is concerned, we are also in the very late stages of the traditional late cycle performers as well, if not topped already. Just take a look at how this thing has run up over the past year. (See Figure 1)
Quite an impressive move not only in terms of percentage gained (1389 - 831 / 831 = 67%), but against the S&P 500 as well, which was only up half that amount at 33% (1033 - 776 / 776). Why does this out-performance happen in one group against the others? Well, that's really a complicated and long explanation, but the two big reasons as I see them, particularly in this case because of the mania we are unwinding, are as follows:
• Institutions and brokers that utilize public funds have to sell the idea to clients that putting money back into the market is a good idea. And its pretty hard to convince most to buy back the same thing, which was growth oriented in the big run-up a la `99/'00, so they recommend a value based approach to their clients, and it becomes the proverbial self fulfilling prophesy, which goes hand in hand with the once burned twice shy adage, as well.
• Secondly, and rightfully so, the question remains, if stocks fell so hard in the sell-off, how can one be sure that growth will return? After-all, the stock market is suppose to be the full reflection of economic conditions now, as well as discounting into the future, so the question remains, "why did it sell off so hard?" Caution must be warranted investors say to themselves. The economy is going to have to prove itself before the market will embrace growth once again.
This realization goes a long way to explaining why value has performed so well over the past year against most other groups within the S&P 500 index. Furthermore, and even though it may not appear that way because of all the jabbering you may hear in the various media sources, previous high beta performers are not what they use to be as a group. You only have to take one look at a representation of the growth group to get that picture clear as a bell. (See Figure 2)
Not only was the performance of growth over the past year far below that of value, as measured by our representations above, it now appears growth is about to breakdown against the S&P 500 before value, and in a very steep fashion, I may add. In my estimation, and upon this occurrence, the market as a whole should commence its accelerated decline into the final wave down in this first part of the bearish long-term cycle, which by the way, could potentially be characterized by two more such episodes over the next ten plus years. In looking at the ratio between our two measures, one can garner the potential severity of the swings that are coming. This next one should be quite the blowout to the downside, which will mark the end to the first big move commenced in the year 2000. (See Figure 3)
As you can see above, and much like the recent study I performed on the S&P 100 Bullish Percentage Index utilizing linear cycle lines, which simply measure equal intervals between peaks or troughs, we seem to have skipped a beat in the last cycle occurrence when lows should have been experienced. With intervals measuring five-quarter spans, this means that over the next two quarters, again matching the timing from the above mentioned study exactly, a violent catch-up move to low values should occur.
What is the probability of such an occurrence? Well, this pattern is the trend and that is a big plus in its favor. More specific observations supporting the likelihood of lower values occurring at the next cycle line interval are as follows:
• RSI is indicating bearish divergences in both the long and short-term view.
• Ratio values have hit stiff resistance as indicated by the proximity to the black dashed rails dating back to 1997.
• The Elliott Wave count is indicating the possibility of a bearish three-wave affair within Wave E indicated above.
• A diamond has formed in the MACD Histogram, which when coupled with the evidence of other indicators, suggests a significant amount of negative energy has been built up within stochastic influences, indicative of a potentially trend setting counter move release.
• Stochastic indications, as measured utilizing Fibonacci based settings (89, 55, 21) are approaching/at significant resistance, potentially reversing into a sinusoidal pattern originating in 1998.
I can tell you one thing; you either have to have a lot of guts, or no brains, to be considering the pursuit of the above trend higher at this time. The best case scenario is there would be a slight retracement anytime now, followed by one more surge higher to complete five sub-waves in Wave E, but I would have to liken this kind of thinking to a quick trip to Vegas to unload some money that you apparently don't need.
The last thing I would like to do is to dispel some potentially loose thinking that a bull on the markets might be saying to himself at present. He would say, "if the above ratio is about to break down, meaning that growth will be outperforming value once again, just like in the bubble years in '99 & '00, doesn't that necessarily mean that growth is returning, and the markets continue higher?" In one word, the answer is no. The reason the answer to that question is "no" is depicted in Figure 2, which is why we endeavor to dissect things the way we do, in that growth is about to breakdown against the group, as represented by the S&P 500. In order for a trend change in the above ratio to be read as being bullish, one would have to be observing the opposite in character.
Good investing all.