Ranking The World Cup Teams and the Market

The S&P 500 (SPX) and the Dow Jones Industrial Average (DJIA) each fell below their February correction lows during the most recent correction as did many of the broader based international equity indices. However, such as is often the case, a further look underneath the surface shows some pretty interesting developments. First, there are a number of indices that have remained above their February correction lows. Secondly, those indices that remain above their February lows are also those areas that have been exhibiting superior relative strength characteristics for some time now. They include: US Small Cap, US Mid Cap, US Equal Weighted S&P, and Growth. In other words, these indices are showing a positive divergence versus the rest of the broad equity market.

How do I know this? I will provide an example using national soccer teams:
The World Cup, one of the world's most watched sporting events, started this past weekend, 32 national soccer teams will compete in South Africa; like the Olympics, the World Cup rotates around the world every four years.

If you see the Brazilian team play, you'll notice a game of quick dance-like moves, efficient passing, and flare. However, if you see the Italian team, they play with staunch defense, but will suddenly and aggressively implement a counter-attacking strategy that often catches their opponents flat-footed. Although the two styles of play differ immensely, Brazil and Italy have won over half of the World Cups played. These two very different approaches have been tremendously successful, proving there is indeed more than one ‘right answer’ to the question of how to win a world cup. In soccer like in my business, employing a sound strategy and employing it well, leads to success over time. There is no one single investment approach that is right for the temperament of all investors, but a great many that can be ‘right’ if applied correctly. Relative Strength-based risk management using the Point and Figure methodology is my ‘style of play,’ and it works for me.

One reason I rely on relative strength is the simple fact that it gives me the objective capability to rank different assets and instruments. It does not matter if it's a stock or an ETF, I can compare it against another, and then rank them from strongest to weakest. This same concept of using rankings can be found almost everywhere in sports, including soccer. The Fédération Internationale de Football Association (FIFA) puts together the FIFA/Coca-Cola World Rankings to objectively rank the national teams from strongest to weakest - with the expectation that those at the top will most likely continue to perform better than the teams at the bottom. Does this sound familiar? The ranking tools I employ operate similarly, comparing different assets against each other and then ranking them from strongest to weakest, the assets at the top of the matrix have developed trends of outperformance, and history has demonstrated that these trends tend to sustain themselves for extended durations of time, so I look to these leaders to remain leaders until proven otherwise.

Currently, Brazil, Spain, Portugal, Netherlands, and Italy are the five strongest teams out of 202 entering the tournament. Simply put, the teams at the top have been performing better relative to the other teams. So, by having the strongest performance over the last few years, the teams at the top, have exemplary relative strength characteristics – just like what I want to own in your portfolio. The teams at the bottom of the ranking exhibit the lowest RS readings. In anticipation of the World Cup, we should expect to find Brazil and Spain making a strong push toward the finals.

In summary, by using relative strength I am able to rank the different ‘parts’ of the market. So as we go through the current market correction, we continue to hold the strongest sectors and shed those sectors dropping in rank while keeping an eye toward the future market leaders so we can add them to the portfolio when the time is right.

Securities and Investment Advisory services offered through NBC Securities, Inc., Member FINRA and SIPC. Investment products 1) are not FDIC insured, 2) not guaranteed by any bank and 3) may lose value including a possible loss of principal invested. NBC Securities does not provide legal or tax advice. Recipients should consult with their own legal or tax professional prior to making any decision with a legal or tax consequence.This is not an offer to sell or buy any securities products, nor should it be construed as investment advice or investment recommendations.

Looking Under the 'Hood' of the Market

Since peaking about a month ago, the S&P 500 (SPX) has given back about 12%; however, as I continue to look ‘under the hood’ of the market, there have been some interesting developments from a relative strength (RS) perspective.

Today, there are 13 out of the 40 US economic sectors that have a higher RS reading than on April 23rd. By the way, 38 out of the 40 economic sectors produced positive returns last year (2009) and certainly, some sectors did better than others, but simply being in the market produced attractive returns. However, as we are now five months into 2010 it is becoming more and more apparent that having a tactical sector rotation strategy is going to be extremely important going forward. So far, there are 22 out of the 40 sectors which have produced positive returns this year. In other words, without a disciplined strategy you had roughly a 50 / 50 chance at picking a winning sector this year.

The correction for the vast majority of strong relative strength names has been just that - a correction, many investments are still in positive trends with strong technical attributes.
While volatility can wreck havoc on an investor's psyche, it is also the reason why equity returns are higher than returns on more stable assets like CD's.

Securities and Investment Advisory services offered through NBC Securities, Inc., Member FINRA and SIPC. Investment products 1) are not FDIC insured, 2) not guaranteed by any bank and 3) may lose value including a possible loss of principal invested. NBC Securities does not provide legal or tax advice. Recipients should consult with their own legal or tax professional prior to making any decision with a legal or tax consequence.This is not an offer to sell or buy any securities products, nor should it be construed as investment advice or investment recommendations.