Archive for March, 2015

Market Trend Analysis by Comparing Equal Weight to Market Weight Indexes

Friday, March 27th, 2015
  • Breadth of trend participation within an index is an indication of trend strength
  • Ratio of equal weight index to market-cap weight index prices is an indication of breadth
  • Broad Russell, S&P and NASDAQ indexes are in uptrends, but the underlying breadth is not highly supportive of continuation
  • Healthcare and Consumer Staples have best up trend confirmation from equal weight to market-cap weight breadth indicator
  • Energy has best down trend confirmation from equal weight to market-cap weight breadth indicator

As a generality, a healthy stock market up trend has broad participation in the trend by a large or increasing portion of its constituents; and conversely an unhealthy market has a low or declining portion of it constituents participating in an up trend.  That logic can be referred to as breadth analysis.

Broad or increasing breadth indicates a strong or strengthening market, while narrow or decreasing breadth indicates a weak or weakening market.

There a variety of ways to get at the question of breadth, such as studies of new highs and lows, price advances and declines, volume advances and declines, percentages of index members above selected moving averages, percentages of members with Bullish Point & Figure charts, and some others.

Equal Weight Indexes Indicate Breadth:

In this article, we look at the relative performance of equal weight versions of indexes, versus the primary  market-cap weighted versions of indexes.

Market-cap weighted indexes  heavily reflect the price action of the largest constituents (e.g. Apple is 4% of the S&P 500), while equal weight indexes treat all constituents the same (e.g. Apple is 1/5th of 1%% of the equal weight S&P 500).  Therefore, market-cap weighted indexes mask the underlying strength of the broad membership of an index.

It is probably safe to say this about rising market-cap weighted indexes:

  • if market-weight index is rising, and the equal weight index is roughly tracking the market weight index, the trend is stable.
  • if the market-weight index is rising, and the equal weight index rising, the up trend is strengthening
  • if the market-weight index is rising, and the equal weight index is falling, the up trend is weakening

For falling market-cap indexes, the converse logic may not be quite as clear in each scenario, but clearly a falling equal weight index accompanying a falling market-weight index is a confirmation of the market-weight index decline.

Summary of Breadth Study Results:

When we looked at some key indexes, and also the S&P 500 sector indexes, we found this:


The Russell 1000 large-cap and Russell 2000 small-cap indexes are rising (as measured by the slope of the 200-day average over 1-year and YTD, and by the position of the price above or below the 200-day average); however, the ratio of the equal weight index to the market-cap weighted index is declining, indicating a weakening of the market-cap index up trend.

The S&P 500 is also in an up trend, but the ratio of the equal weight to market weight indexes is a bit flat, putting somewhat of a question mark on the power behind the primary market-cap index up trend.

The NASDAQ 100 is in an uptrend too, and its ratio of the equal weight to market weight indexes is a bit weaker than for the S&P 500, also putting a question mark on the power behind the market-cap index.

Considering the Russell, S&P and NASDAQ indexes as a group, it appears that the overall uptrend is running out of steam.

Within the S&P 500, the strongest support from the equal weight to market-cap weight ratios is for Healthcare and Consumer Staples; with Basic Materials and Financials as a second tier.  No surprise, Energy is in the worst shape.

We made the ratings by visual inspection of charts which are provided below.  You can judge for your self how they should be rated.

Other Sector Breadth Indicators:

As a cross check we looked at the sectors through two other breadth indicators, plus the technical rating from

For breadth we looked at the percentage of index members with Bullish Point& Figure Charts and the percentage of members with prices above their 200-day average.

That data confirmed Healthcare as strong, as well as Consumer Staples, but contrary the equal weight to market weight indicator, it shows Consumer Discretionary as strong.

Also contrary to the equal weight to market weight indicator, it shows Basic Materials to be weak, and Financials to be so-s0.

All agreed that Energy is in the tank.

Which indicators are better forecasters is unknown, but it’s good to have multiple angles of attack to the question of trend strength.

__Sectors Techniccals

Taken All Together:

Taken all together, this data suggests the broad stock market indexes are getting a tired.

Don’t forget that even the best stocks have a hard time staying up when the broad market decides to go down.

While some return could be left on the table, prudence might suggest holding some tactical cash, against a market correction that seems overdue, subject to some high profile trigger event on the horizon (such as Fed beginning to raise Fed Funds Rate, or worse results from Q1  due to Energy sector or strong Dollar, some new turmoil in Europe, or a wider war in the Middle East).

For those following trends, Healthcare and Consumer Staples may be the best place to be; although arguments about potential overvaluation need to be considered.

For those seeking bargains, a lot of patience, tolerance of short-term pain, and a conviction that oil will recover to the $60-$80 range, Energy may hold some opportunities.

Chart Data Behind the Equal Weight to Market-Cap Weight Table:

Each chart below shows in the top panel the ratio of the equal weight ETF price to the market weight ETF price (shown as the 5-day EMA in black), along with the 200-day EMA in gold.  In the bottom panel, the market weight index is plotted in blue with its 200-day EMA in gold.


Main index (IWB) trend line is rising, but breadth trend line (EWRI equal wt / IWB market wt) is deteriorating.  A little pick-up in breadth in 2015, but breadth trend line (200-day EMA) is rising YTD.


The main index (IWM) is rising, but the breadth trend (EWRS / IWM) is deteriorating.

S&P 500:

The main index (SPY) is rising, and the breadth index trend (RSP / SPY) is about steady.  The short-term, 5 day breadth took a dive in October 2014, but not enough to divert the flat breadth trend line.



The main index (QQQ) trend is rising, and the breadth indicator trend (QQEW / QQQ) deteriorated in 2014, but has stabilized YTD.


S&P 500 Consumer Discretionary Sector:

The main index (XLY) trend is rising, and the breadth trend (RCD / XLY)  is generally steady, but the 5-day breadth is down YTD.


S&P 500 Consumer Staples Sector:

The main index (SPY) trend is rising, and the breadth trend (RHS / XLP) is also rising.

S&P 500 Basic Materials Sector:

The main index (XLB) is rising and the breadth index (RTM / XLB) is rising since December 2014.

 S&P 500 Energy Sector:

The main index (XLE) trend is declining and the breadth trend (RYE / XLE) is also declining.

 S&P 500 Financial Sector:

The main trend (XLF) is rising, and the breadth trend (RYF / XLF) is rising slightly in 2015.


S&P 500 Technology (and Telecom) Sector:

The main index (XLK) trend is rising, but the breadth trend (RYT / XLK) is basically flat.


S&P 500 Healthcare Sector:

The main index (XLV) trend is rising, and the breadth trend (RYH / XLV) is rising strongly, with the 5-day EMA well above the 200-day EMA.


S&P 500 Industrial Sector:

The main index (XLI) is rising, but the breadth trend (RGI / XLI) is mostly flat, with a strong improvement in 2015.


S&P 500 Utility Sector:

The main index (XLU) trend has been up, but is flat now, and the breadth trend (RYU / XLU) is also flat.





Treasury Dept Warns of “Quicksilver” Risk in a High Valuation Stock Market

Wednesday, March 25th, 2015

The Office of Financial Research at the US Treasury, published a brief on March 17, warning of historically high valuations in the US stock market, and the potential for a sudden and painful drop in prices.  It’s worth a read.

The eventual move by the Fed to raise interest rates, while likely modest, and while at rates well below rates that have not been a problem for stocks in the past, is likely to cause a degree of shock that will create a correction.

The basic argument by the OFR is that when certain ratios reach 2 standard deviation distances above their very long-term averages, they create great risk of a corrective movement back toward the long-term average.  That “mean reversion” tendency is a real thing, but when and whether the reversion takes place is hard to pinpoint.

They make note of the fact that the stock market has seemingly stretched valuations, at the same time that the economy as they describe it is not doing all that well.

The three indicators they present are:

  • Shiller CAPE Ratio
  • Tobin Q Ratio
  • Buffet Market Value to GDP Ratio

The CAPE Ratio (10-year CPI adjusted P/E) is approaching 2 standard deviations, and is at the approximate level of 2007.  The only two times it exceeded 2 standard deviations by this measure was in 1929 and 1999 — both bad years to own stocks.  However, the indicator did not signal the 2008 crash early enough to save a lot of money.


The Q Ratio (replacement cost of plant and equipment of public and private non-financial companies versus their financial statement net worth), is approaching 2 standard deviations.  However, the indicator did not signal the 2008 crash.



The Buffet Indicator (total stock market-cap divided by GNP) is approaching 2 standard deviations.  The indicator may have turned early enough for a close watcher to get out of the way of 2008.


The article goes on to identify other concerning facts, such as:

  • forward P/E ratios in common use having little predictive value
  • valuation arguments based on low interest rates not considering the macro-economic implications of low interest rates
  • historically high profit margins before and after tax
  • total profits 10-year rolling average above the regression trend of the average, and total profits above the 10-year rolling average
  • poor stock returns in years following high valuations
  • high margin debt at historically high percentage of total stock market value.

On a more optimistic note, David Rosenberg of Gluskin Sheff, made a strong statement a few months ago, that virtually all bear markets are preceded by an inverted yield curve (short rates above intermediate rates), and the Fed raising the discount rate.

We think his ideas are more compelling, because they directly deal with the investor alternatives of debt or equity, and the effect of interest rates on the ability of companies and households to borrow and for companies to cover interest expenses.

Looking only at the 2000 and 2008 crashes, we see s0mething a tad different than Rosenberg, but still using his favorite indicators (the yield curve as implied by the 2yr-10yr Treasury yield spread; and the Federal Funds Rate).

This weekly chart shows the Fed Funds Rate in the top panel (blue), the 2yr-10yr yield spread in the middle panel (red) and the S&P 500 in the bottom panel, along with its 40 week moving average, and the reported GAAP earnings per share.

Here is what we see.  When the S&P 500 falls below its 40 week average AND the yield curve has been flat (1.00 on scale) and then begins to steepen, AND the Fed Funds Rate begins to fall; that coincided with the tops.  We are not anywhere near those conditions now.

However, history does not repeat — it only rhymes; and there has not been a period in the US in the past like this one.  Perhaps investors are so used to zero interest rate policy that they will panic once debt starts to pay a little more.  We’ll see.  What do you thin?

(click to enlarge)




Best Relative Sortino Risk Adjusted Returns For ETFs and Mutual Funds

Sunday, March 22nd, 2015
  • Investors in the withdrawal stage of their financial lives are well served to select investments with an eye toward above average risk adjusted returns to minimize the risk of outliving their assets
  • Higher risk adjusted returns are not always the highest returns, but they can be the least emotionally or financially dangerous returns
  • Over the past 10 years, very few non-US funds have achieved better risk adjusted returns than the S&P 500
  • Healthcare funds have dominated the best risk adjusted returns, along with large-cap funds

Investors in the withdrawal stage of their financial lives may prefer a smooth ride with a good return more than a very bumpy ride with a better than good return.

That is because volatility during withdrawals can deplete the assets of the portfolio dangerously, increasing the “risk of ruin” (outliving assets).

Fixed dollar regular periodic accumulation improves return, and regular periodic fixed dollar withdrawal has the opposite effect.

It is volatility that makes regular fixed dollar periodic accumulation beneficial, and it is volatility that makes regular periodic fixed dollar withdrawal harmful.

With those ideas in mind, we looked for ETFs and mutual funds (collectively “funds”) that had better volatility risk to total return ratios than the S&P 500.  Because upside volatility is beneficial and not harmful to a portfolio during withdrawals, we chose to use the Sortino Ratio instead of the Sharpe Ratio.

The Sortino Ratio is like the Sharpe Ratio (total return in excess of risk-free rate over the standard deviation of return), but only considers downside volatility.

We looked for funds that had a higher Sortino Ratio for 3 years, 5 years, and 10 years, and that also had a total return at least 90% of the return of the S&P 500 (as represented by SPY for ETFs and by VFINX for mutual funds) for each of 3, 5 and 10 years, as well as 1 year, with at least a positive return YTD.

We chose to require a 10-year history to include the build up to and the experience of the 2008-2009 stock market crash.

For ETFs, we looked at the 500 largest by assets.  Only 17 passed the filter:

iShares US Consumer Services IYC
Vanguard Consumer Discretionary ETF VCR
Consumer Discret Sel Sect SPDR® ETF XLY
Vanguard Consumer Staples ETF VDC
Consumer Staples Select Sector SPDR® ETF XLP
iShares Nasdaq Biotechnology IBB
iShares Global Healthcare IXJ
iShares US Healthcare IYH
Vanguard Health Care ETF VHT
Health Care Select Sector SPDR® ETF XLV
iShares S&P 500 Growth IVW
iShares Russell 1000 Growth IWF
iShares Morningstar Large-Cap Growth JKE
SPDR® S&P 500 Growth ETF SPYG
Vanguard Growth ETF VUG
First Trust Value Line® Dividend ETF FVD
iShares Morningstar Mid-Cap JKG

The ETF list is dominated by large-cap growth and healthcare:

  • 5 large-cap growth ETFs
  • 5 healthcare ETFs
  • 3 consumer cyclical ETFs
  • 2 consume defensive ETFs
  • 1 large-cap value ETF
  • 1 mid-cap growth ETF

This table shows the relative risk adjusted level for the ETFs as well as their Sortino Ratios and rolling returns.

(click to enlarge)

ETF rolling

This table shows the relative risk adjusted level, plus the calendar year returns for 10 years.

(click to enlarge)

ETF calendar

For mutual funds, because there are over 8,000 mutual fund portfolios with over 27,000 share classes, we wanted to reduce the universe to inspect.  Therefore we filtered for several additional criteria, including:

  • retail availability at Schwab or Fidelity or Vanguard
  • total assets of at least $100 million
  • minimum initial purchase not more than $100,000
  • not closed to new investments or new investors
  • no front or back loads (other than short-term redemption penalty or transaction fee)
  • average or better Morningstar overall rating
  • average or higher 3-year and 5-year  Morningstar return rating
  • average or lower 3-year and 5-year Morningstar risk rating
  • downside capture ratio for 3-years and 5-years less than 100

Only 18 mutual funds passed that filer:

Fidelity® Select Consumer Discret Port FSCPX
Vanguard Consumer Discretionary Idx Adm VCDAX
Vanguard Consumer Staples Index Adm VCSAX
Fidelity® Select Pharmaceuticals Port FPHAX
Fidelity® Select Health Care Portfolio FSPHX
BlackRock Health Sciences Opps Svc SHISX
Schwab Health Care SWHFX
Vanguard Health Care Adm VGHAX
Vanguard Health Care Index Adm VHCIX
Parnassus Core Equity Institutional PRILX
Vanguard Dividend Growth Inv VDIGX
Chase Growth N CHASX
Hennessy Focus Investor HFCSX
Janus Enterprise T JAENX
Nicholas NICSX
Nicholas Equity Income I NSEIX

The mutual fund survivors consisted of:

  • 6 healthcare funds
  • 3 US large-cap blend funds
  • 3 US mid-cap growth funds
  • 2 US large-cap growth funds
  • 2 consumer cyclical funds
  • 1 consumer defensive fund
  • 1 US mid-cap value fund

This table shows the relative risk adjusted level for the mutual funds as well as their Sortino Ratios and rolling returns.

(click to enlarge)

MF rolling

This table shows the relative risk adjusted level, plus the calendar year returns for 10 years.

(click to enlarge)

MF calendar

Notably, only US focused funds passed the filter.

Because of the 2008 crash, and the fact that the US central bank was the first to do strong quantitative easing, that is part of the reason non-US funds don’t pass the filter. Perhaps, that will change as other nations’ central banks try to catch up, and as the US central bank backs away from its easy money policy.  That certainly deserves close watching.

Unfortunately, there is no way to measure or filter the future, only the past.

Recently, certain currency hedged foreign index funds have surged in return, popularity and assets, while their unhedged analogs have lagged or declined.

The good part of that is obvious. However, because those hedges are permanent and not actively applied, the benefit will reverse and become harm when the Dollar stops its rise as it does in cycles.  Actively managed hedge funds can take off their hedges when the Dollar declines, and may be a better choice.

Taking currency risk is not for the unwary.  When choosing a hedged index fund over an unhedged fund you have to be right twice. You have to be right about the stock markets, and right about the currency exchange rates.  Be careful with hedged/unhedged index fund choices.

We will update this list from time-to-time to attempt to identify shifting patterns of success.

Note that healthcare would probably be more strongly represented among the mutual funds were it not for some strong funds being closed to new investors.

Here are 10-year, weekly performance charts for the ETFs that passed the filter.  The charts (from show the cumulative total return performance, as well as the 1-year moving average in gold and the 1-year price range in a light blue area around the price.


Here are 10-year, weekly charts for the mutual funds that passed the filter.  Note that one chart (HFCSX) has the appearance of a short history.  This is a lack of data at StockCharts which will be corrected soon, but meanwhile, we have added a 10-year chart from Morningstar below for that mutual fund.



While ETFs remain available to all so long as they are available to anyone, mutual funds are not the same.

Sometimes mutual funds close to new investments from new investors, or from all investors; and sometimes they open up after being closed.  Sometimes mutual funds restrict access to those investing directly through the sponsor (as is the case with some Vanguard funds).  Sometimes a fund will be unavailable or restricted at one broker and available at another.

Those conditions change over time, so this is just a current snapshot.

As must always be said, the past is not the future, but taking the past into consideration is wise, we believe.

It may well be that one or more of the funds in this article could be a good addition to, or core element, in a portfolio;  particularly a portfolio in the withdrawal stage where relatively low volatility is key to long-term financial health.

Disclosure: QVM or certain clients have positions in FSPHX, VDIGX, NICSX, XLY, XLV, IBB, and SPY as of the creation date of this article (2015-03-22).

General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.

Don’t Worry About Fed Funds Rate Rise Like the Panicking Media

Thursday, March 12th, 2015


The media is full of worry — will “patient” be kept or removed from their next statement? When will they begin raising the Fed Funds Rate? They worry that when the Federal Reserve begins to raise the Federal Funds Rate (the rate banks charge each other on a very short-term basis to loan each other their excess reserves), that the stock market will go into a tail spin.

It is true that there are some worried “players”, and they will most probably cause the stock market to experience a transient dip (maybe a correction of up to 10%), but history says their concerns are unwarranted.

Admittedly, there has never been a time when rates have been so low or for so long, and maybe the addiction to low rates will make the negative reaction to a rate move toward a more normal (or “un-suppressed”) market more severe. But in the end, rising interest rates within “normal” ranges DO NOT cause stocks to go down.

As we have shown before, when short-term rates exceed longer term rates (an “inverted yield curve”) bad tidings are with us, but the Fed is not talking about that. They are talking about raising the Fed Funds Rate from a 0% to 0.25% rate to an incrementally higher level, and maybe several increments over a series of periods, but not about raising them above longer-term rates.

Consider first, the relationship between 10-year Treasury yields and the performance of the S&P 500, as shown in this chart from JP Morgan Asset Management.

This chart shows the Treasury yield on the horizontal axis and the correlation of S&P 500 stock prices to the Treasury yield from 1963 through the current time. It shows that stock prices RISE with rising interest rates over a 2 year rolling period up until the 10-year Treasury reaches about 5%. It is currently around 2%. Rates rise because business is improving, and that means profits are improving and stocks like that.


Now to the Fed Funds question (and information on 2-year Treasury rates and 10-year Treasury rates). This 20-year weekly chart (1995 through current 2015) shows the S&P 500 in the top panel, the Fed Funds Rate in the next panel, followed by the 2-year Treasury rate and the 10-year Treasury rate in the bottom 2 panels.

The takeaway is shown by the slanted red lines drawn on each panel. It shows that as a generality, most of the time when those three rates are rising, the S&P 500 was able to rise as well.


We went back further and looked at 1980 – 1994, and found the same general relationships.


There are things to worry about, and other things to move stocks down, but over a reasonable holding period, rising interest rates from low levels does not appear to be of great concern.

In fact, a knee jerk down spike in stock prices when Fed begins raising rates, may turn out to be a good buying opportunity, rather than time to run away and hide in cash.