Updated: Sep 2, 2021
When analyzing stocks, there’s more to evaluate than simply revenue, valuation, and industry trends (i.e., fundamentals). Of course, these factors are essential, but they don’t always show up in the market price. That’s why we also do what’s called technical analysis. You’ve probably heard me refer to technical analysis as reading tea leaves because the process involves a level of subjective prediction based on historical data.
Chris Arends, our Portfolio Analyst, has even more confidence in technicals. He considers technicals “astrology for adults”! We joke, but we do spend a lot of time analyzing technicals. We know that factor investing does work, and a lot of times, reading the charts and technicals will get us a particular element in the market and a signal through the noise.
Let’s jump in and look at the different asset classes we typically review during technical analysis.
Performance of Asset Classes on a Technical Analysis
Looking back to August 20-24th, we see crude oil rebounding quickly. But then, if we look at a seven-day window, we can see that the Russell 2000 is positive, and the NASDAQ composites are up — as well as gold and the core bond. Therefore, there is a quality bias to these types of asset classes.
S&P 500 Large Cap Index
Looking at the images above, you’ll notice how the S&P 500 is moving on the left chart. A point and figure chart are on the right, which is an excellent way to see where support levels are. So, for example, you can see the July bottom was at 42/30, and in June, it was at 41/60. One thing to note is that the S&P 500 is one of the few indexes having a breakout while also making new all-time highs.
Now, let’s review the Russell 2000 small-cap. You’ll notice it doesn’t have a quality factor like other indexes. We can see that it had been trending up for quite some time and had significant outperformance, but it’s been a flat line since April.
Another way to think about this is by dividing the Russell 2000 by the NASDAQ 100. Whenever the Russell 2000 (purple line) moves up, it outperforms the NASDAQ 100. Then, when it’s moving down, the NASDAQ 100 is outperforming the Russell 2000. We can also compare it to the interest rate on the 10-year treasury (on the axis). As you can see, we start below 1%, move up to 1.75%, and then back to 1.2%. The trend that we notice here is when interest rates move up, the Russell 2000 outperforms. Then, as interest rates decrease, the NASDAQ comes back in.
MSCI EAFA compared to the S&P 500 Sector Weighting
Next, when we look at international indexes, we analyze demographics and other characteristics besides the value growth aspect. But you want to be cautious about entering any global indexes because of low price to earnings. So, let’s look at the exposure breakdown of the broad index of international developed companies compared to the S&P 500 based on the sector below.
First, cash or derivatives are being minimal on the amount of money they hold. Then, we can see that the EAFA holds 4.68%, while the U.S. holds 11.26% in large-cap. If we go to the biggest holding in the international index, we can see its financials at 16.74%, while the U.S. is 11.12%. Therefore, there is a significant overweight relative to the U.S. markets towards finance. On the other side, if we look at information technology, the S&P 500 has almost 30% waiting while the EAFA has less than 10%.
One Belt, One Road
In the last couple of months, it has become a tough market in China, which makes up about 30% of the emerging market benchmarks and indexes. Some excellent companies look innovative, but as soon as they start looking too good, the communist party overpowers them. This isn’t a political issue but rather geopolitical. The real question is, is China investible?
Also, the problems occurring in Afghanistan have a significant impact on the market. China has been working on the ability to create this “one belt, one road.” Historically, the red line represented the Silk Road until the west became a maritime superpower. Then, England went through and built the Suez Canal, where they could control trade. Now, China is trying to make inroads into reopening that Silk Road. But, then, with the power vacuum in Afghanistan, we’re starting to see them approach the Taliban as the U.S. leaves.
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