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Dow Jones Industrials, Russell 2000: Signs of What's to Come?


The S&P 500 and the Nasdaq-100 have yet to surpass their closing all-time highs. That means it's time for investors to ascertain where the best reward/risk metrics are.

All aboard! Ha ha ha ha ha ha haaaa!
-- "Crazy Train," Ozzy Osbourne

Whatcha want, alpha or relative alpha?

Last week's editorial penned the question, "Should investors take the risk-off trade?" This inquiry was based on the technical convergence of the major long-term (secular) resistance and an intermediate-term channel top. When adding in the overblown political bantering about the sequestration – behavioral finance/market psychology – it seemed appropriate to discuss the potential. Our firm's stance, which is 90% quantitative fusion analysis, was to not remove the "risk-on" trade until the S&P 500 Index (INDEXSP:.INX) pre-Thanksgiving shorter-term trend (trends within trends) was breached (~1,500). This proved to be correct with the "Crazy Train" equity markets pushing higher again as investors continue their buying spree.

Interestingly enough there are still two sister indexes left that have yet to surpass their closing all-time highs: the S&P 500 and the Nasdaq-100 (INDEXNASDAQ:NDX). If the Dow Jones Industrials (INDEXDJX:.DJI) and the Russell 2000 (INDEXRUSSELL:RUT) are the telltale signs of what's to come, it's again time to ascertain where to allocate, or reallocate, for the best reward/risk metrics. As everyone knows there is a great deal to consider when opening this can of worms. But one easy metric to look at is momentum and strength -- relative strength, to be more specific.

At my firm, we look at comparative metrics, not only to ascertain directional moves, but where to see where short, intermediate, and longer-term money flow is heading. This is most easily accomplished graphically. Otherwise stated, if one's objective is to not only capture relative alpha, it's only logical to allocate a portion (determined by one's own risk tolerance) to the areas of greatest demand. This is where investors will find an increase in their relative alpha.

Most investors use the SPX as their relative strength comparative. We prefer to use a much broader index of the US equity markets; a total market index. For ease of understanding today we use Vanguard's Total Stock Market ETF (NYSEARCA:VTI). This is akin to the Wilshire 5000 Index (INDEXNASDAQ:W5000). On a side note: When charting strength, it's important to use correction low dates to start the graph. (For further reasoning behind this refer to The Market's 'Four Sister' Indices Show a Changing of the Guard Is Underway, which discussed this specifically.)

Click to enlarge

The above charts and table show the longer, intermediate, and shorter-term trends of the four sister ETFs: SPDR S&P 500 ETF Trust (NYSEARCA:SPY), SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA), PowerShares Nasdaq 100 Index ETF (NASDAQ:QQQ) and the iShares Russell 2000 Index ETF (NYSEARCA:IWM) along with the VTI. The dates chosen are the lows from June 2012 (upper right), November 2012 (bottom left), and 2013 YTD (bottom right). The table (top left) depicts all four against the total market index. It is plain to see where the strength is stemming from and this sheds some interesting light on the fact that the three eldest sisters have been underperforming the total market for both the 9- and 4-month periods.

Simply put, by separating the time scales it becomes much easier to determine money flow (demand). We use this to back up and/or confirm our other research into allocation stance. This can not only be done on a broader index basis, but also evaluated on the sectors and industry groups within.

I've listened to the preachers
I've listened to the fools
I've watched all the dropouts
Who make their own rules
One person conditioned to rule and control
The media sells it and you live the roll

-- "Crazy Train," Ozzy Osbourne

I hope this helps and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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