For our readers in the United States, we hope this update finds you refreshed after the long weekend and remembering those who gave their life to ensure their fellow countrymen remain free. The U.S. Markets were closed for this important observance, with trading resuming this morning. If you’re a regular reader of our work, you know it’s important to take a look at price, markets, and trends from different angles. Any edge we can gain in identifying opportunities is valuable. In this week’s post, we want to show you an important index you’ve probably never heard of that can provide valuable insights regarding the health of the U.S. stock market: the Value Line Geometric Index (XVG). This index tracks the median move of stocks within the index using the assumption that each stock has an equal amount (for example, $1,000) invested in them. The daily average move of this index is calculated geometrically (rather than arithmetically). I don’t want to bore you with the details, but if you need more info, you can read more about the methodology here, page 4. More simply put, this index eliminates an illusion created by weighted index components. Weighted stocks within an index can pull it higher even as the majority of the stocks within the index are not following along. For example, in a weighted index like the S&P 500, it’s possible for the top 100 weighted stocks to carry the index higher while the remaining 400 stocks lose value. As an investor, it might be helpful to identify when this is happening.
By looking at the Value Line Geometric Index alongside the S&P 500, we gain valuable insight into what is currently taking place in the market. Looking at the chart below, the Value Line Geometric Index is in the upper panel and the S&P 500 in the lower.
Notice the equal-weighted Value Line index is holding steady above the highs of 1998, 2007, and 2015 while the S&P 500 has continued higher (divergence). This condition has been persistent since December 2016. This means the market is thin: money is flowing into large cap stocks and leaving the rest behind. This is a stock picker’s market and can be a hallmark of market tops, but is not a guarantee a price correction is upon us. It should be noted when looking at the chart above that this condition can persist for quite a while before there is an overall resolution to the market (aka a correction in price). In the past, a noticeable divergence developed between the Value Line Geometric Index and the cap-weighted S&P 500 before the S&P 500 corrected in price. This doesn’t mean the S&P will correct in price right now or at all. But, it does mean that it is getting harder to find U.S. stocks that are trending up. If the majority of U.S. stocks are flat or down, what stocks are carrying the market higher? Awesome question. Let’s take a look at the data. Here’s a great visual from Financial Times using data from Bloomberg:
This chart shows while most stocks within the S&P 500 have been flat, it’s Technology pulling this major index higher. Many assume when the S&P 500 records new highs, it means everything under the surface is participating. This couldn’t be further from the truth. In fact, many sectors are currently underperforming the overall index. Because of tech’s large weighting (over 20%) in the S&P 500, it’s been carrying the water for other sectors currently struggling to gain traction for the past few months.
While the condition persists, market participants will need to be diligent in their stock selection. In addition, we’ll want to watch for clues from the leading sector, Technology, on whether this current run can continue. It’s a positive when economic bellwethers like Apple (AAPL), Amazon (AMZN), Facebook (FB), Google (GOOGL), Nvidia (NVDA), Adobe (ADBE), Microsoft (MSFT), and Netflix (NFLX) can lead. At the same time, it would be healthy if more sectors start to participate. If and when laggards like Energy and Financials find demand, it could signal another strong leg higher for the overall market. But if Technology start to sell off and the Value Line Geometric Index fails to hold these recent highs, it likely means a decent correction will be underway. As always, we don’t need to predict to invest. Price is the only fact that matters. And as long as this condition is in place, we’ll be watching the price of the S&P 500 closely. You should be too.
As always, you can get real-time updates and commentary about this development and many more opportunities here: @360Research
Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in this blog. Please see our Disclosure page for full disclaimer.