#TradeTalks: Using Relative Strength to Identify Winning Sectors & Markets with Dispersions ^
The Dog Days of Summer are here and along with them is a spike in market volatility with renewed Trade War talks, as well as a decision by the Fed to cut rates. Whatever the reason, the month of August has historically been a weak month for the market, ranking 10th out of the 12 months of the year in terms of average return. Since 1950, the S&P 500 Index has seen an average return of –0.1% in the month of August. With that said, it also starts the second half of what we have come to know as the “seasonally weak” period in the market, which is the six month period from May through October. So, this is all to say that seeing a heightened level of volatility during this time of year has, historically, not been an uncommon phenomenon.
Coming off fresh highs in July at 3020, the S&P 500 pulled back about 6% in a rather short amount of time. The pullback caused some deterioration within the short term indicators in the process. For instance, the NYSE Bullish Percent [BPNYSE] reversed into a column of O’s early in August to shift to a status of “Bull Correction,” which can simply be summarized as an environment in which the bull market is taking a breather. Another way to think about the shift to “Bull Correction” is a traffic light moving from green to yellow. We can continue to proceed through the intersection, but need to slow down and look both ways before proceeding.
It was three years ago, this month, when U.S. Equity moved back up to the number one ranked asset within our asset class relative strength ranking tool, DALI, and as we look at the rankings today, U.S. Equity remains number one. As a matter of fact, over the course of the past month U.S. Equity has actually expanded its lead over the number two ranked asset class, International Equity, and as the rankings below show, Fixed Income comes in at number three.
Nasdaq Dorsey Wright Asset Class Rankings (DALI) as of 8/12/19
There are many different applications for DALI in your portfolio management process, as well as strategy construction. Everything from simply understanding which asset classes have the best relative strength to setting specific targets towards investment in those asset classes. As an example, DALI is the basis for the Dorsey Wright Moderate Core Index (DWATTMC), which is an index that is designed to tactically overweight equities in a strong market while having the ability to reduce risk in a weak market based on the asset class rankings of DALI. The goal is to maximize exposure to the number one ranked asset class, which right now is U.S. Equity. If U.S. Equity is number one then the index can have 75% exposure to that asset class. For other asset classes the max exposures are different. For instance, if International Equities were number one, then the max would be 25% while Fixed Income max is 60%. The goal is to systematically overweight the asset classes with the best relative strength and systematically underweight those with the weakest relative strength. This index is available through a First Trust Variable Insurance Trust which is the First Trust Dorsey Wright Moderate Tactical Core Portfolio, and is accessible through both the Lincoln and PacLife Variable Annuity subaccounts. For more information on this strategy click here.
This is one example of how we incorporate the DALI asset class ranking tools into an investment strategy, but certainly not the only way you may choose to include these rankings into your investment management process.
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Unless otherwise stated, the performance information included in this article does not include dividends or all potential transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.
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Dorsey Wright’s relative strength strategy is not a guarantee. There may be times when all assets are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon to be successful or outperform any index, asset, or strategy.
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