Replay Available - Inflation and Relative Strength Investing Webinar: In this webinar from Tuesday, June 29^th, we explored key areas of the market that have shown strong growth potential, and which areas of the market may be poised to participate in an inflationary environment.

Click here to view the replay

Given Monday’s Were You Aware, which looked at forward returns after the S&P 500 (SPX) experienced 12 months of positive monthly momentum, it may not be a surprise to find the Dow (DJIA) in the same boat.

In fact, the Dow has experienced 12 months of positive momentum 12 times since 1905, with the most recent occurrence taking place almost exactly four years ago (6/30). Historically, the Dow has continued this streak past the one-year mark 82% of the time; the greatest run came in 1986 with 23 consecutive months of positive monthly momentum. As you may expect given the lead up and precedence of the SPX study, historically this has also been a bullish sign for markets. DJIA posted a loss in only two of the 12 calendar years following a streak of 12 consecutive months of positive momentum. Furthermore, the mean and median return were 14.92% and 14.01%, respectively, which are both above the longer-term market averages. Of the two negative years, note that each came after instances where the momentum streak ended at the 12-month mark or one month thereafter. Any streak of 14 or more months had a positive return from its initial 12-month date. The charts below help depict the rarity and forward performance, respectively, of past occurrences.

We're excited to announce the launch of our new NDW Morning Video Update Series! Videos are recorded daily, and our goal for the series is to highlight the previous day’s action, touch on changes we are seeing within the market, and provide a learning avenue for users on how to efficiently and effectively navigate the NDW Research Platform through an analyst-guided format. The daily videos are posted by 9 a.m. ET on the NDW Morning Video Update page under the Research tab and are linked directly on the Daily Equity & Market Report. Videos and video archives can also be accessed via the Media & Education page under "Videos".

On the NDW Morning Video Update page located under the Research tab, the most current video is displayed at the very top while an archive of past videos is displayed below. Here, users have the ability to view the videos and download the audio files. When scrolling through the Daily Equity and Market Report, users can quickly access the NDW Morning Video Update page by clicking the "NDW Morning Update" link located on the report's right-hand sidebar. Additionally, the NDW Morning Video Update and video archives are housed on the Media & Education page (located under the Resources menu) under "Videos". If you have any questions on where to find the videos or if you want to learn more about the information discussed within the videos, please call the DWA Analyst Team at (804) 320-8511 or email dwa@dorseywright.com. 

As we head into the second half of the year, we do so with an undoubtedly strong domestic equity market. Both the S&P 500 SPX and Nasdaq NASD reached new all-time highs this week, while the Dow DJIA sits about 450 points or a bit over 1% off of the all-time high it reached in May. After trailing in Q1, the Nasdaq played catch up in the second quarter gaining 9.49%, while SPX was up 8.17%. As a result, NASD now trails the S&P by about 1.7% for the year (through 6/30) after being behind by about 3% at the end of March. We saw a shakeup in Q2 as small-cap stocks lagged their larger-cap counterparts, despite still hanging on to the second-best year-to-date return. We also saw a shift back towards growth stocks after a sharp pivot to value in the prior two quarters. Momentum managed to regain some of its footings throughout the second quarter after having been crowned the worst-performing factor in Q1 and is now back in positive territory for the year. Despite this performance rebound, the Dorsey Wright Technical Leaders Index DWTL finished the second quarter with a gain of 5.38%, causing it to once again underperform the S&P 500 Index SPX by -2.79% as well as the iShares Russell 1000 ETF IWB by -2.77%. As you've heard us discuss before, every investment strategy, whether it is value investing, growth investing, fundamental, or even trend following, goes through periods of underperformance, and Relative Strength investing (RS) is no different. RS laggard periods can be uncomfortable, and when looking in the rearview mirror (early 2016, late 2018, or early 2021), it serves as an unfriendly reminder of this. As you discuss your process with prospects and clients, it's important for them to understand that sometimes RS based strategies such as the Dorsey Wright Technical Leaders Index are not immune to periods of underperformance, however, we have found that the RS has tended to rebound out of these laggard periods, providing, at times, consistent and robust returns. As a result of changing strength, we saw 44 changes (out of 100 holdings) with this most reconstitution in order to reposition the portfolio to areas of leadership which we'll discuss below.

Dorsey Wright Technical Leaders Index Process

The stock-selection process behind the Dorsey Wright Technical Leaders Index DWTL strategy is quite simple yet robust. Every quarter, we apply the Relative Strength process to compare approximately 1,000 large and mid-cap US stocks and select the strongest 100 names. The quarterly reconstitution process's primary goal is to consistently weed out the weak names and realign the portfolio toward strength. With this most recent reconstitution and rebalance, we removed 44 stocks and added 44 new stocks, which we've compiled in the table below. One of the more interesting observations is the "Average Technical Attribute Reading" for the two lists. As of 7/1/2021, the 44 stocks added to the strategy this quarter have an average technical attribute rating of 4.45. The 44 stocks that were removed, however, have a weaker average attribute rating of 2.55. Moving into the third quarter of 2021, the average technical attribute rating for the stocks currently held in the index is now a favorable 4.42. For a full list of the Q3 2021 DWTL holdings, click here.

Dorsey Wright Technical Leaders Index Changes

Dorsey Wright Technical Leaders Index Stats: 

• Technology, which caused the most drag on the DWTL's performance last quarter, accounted for 2.61% of the Q2 total return, the most of any broad sector. Real estate caused the most drag at -0.31%. Healthcare was the second-largest contributor, adding 1.11%. (Source: Bloomberg)
• Currently, the Dorsey Wright Technical Leaders Index is overweight industrials at 21%, followed by technology at 19% and consumer discretionary at 17%.
• Out of the 44 stocks added, the healthcare and technology sectors accounted for most additions at 20.5%, followed by consumer cyclical at 18.2%.
• Of the 44 stocks removed, Discovery, Inc. DISCA was the worst-performing in Q2 with a loss of -29.41%, followed by Penn National Gaming PENN, down -27.04%.
• Consumer cyclical accounted for the majority (34.1%) of the removals this quarter, followed by the industrials sector (20.5%).
• Of the 44 new additions to the strategy this quarter, 27 are perfect 5 for 5'ers while all 44 are high attribute names (3, 4, and 5’ers) trading in overall positive trends (above their respective bullish support lines).

Dorsey Wright Technical Leaders Index Attribution

As mentioned above, momentum-based strategies such as the DWTL rebounded in the second quarter of 2021 after a rough start to 2021. Although the Q2 total return of 5.48% was enough to push the DWTL back into positive territory for the year, it was not enough to outperform the SPY’s Q2 total return of 8.52%. The table below breaks down the Q2 2021 performance of the DWTL versus the SPDR S&P 500 ETF Trust SPY, providing a closer look into what sectors drove each higher (or lower) over the last three months. (Note: DWTL’s total return will be different than the actual return because of the way the performance attribution program calculates returns). 

• Technology was DWTL’s largest average sector weighting over the second quarter at 29.39% and ended as the top contributing sector on a total return basis, adding 2.61%. Technology was also the SPY’s largest average weighted sector as well as its strongest contributing sector, adding 3.07%, 46bps more than DWTL as broad tech exposure outpaced a more concentrated portfolio.
• Despite being underweight healthcare when compared to the SPY benchmark, healthcare added 1.11% to DWTL’s total return, while it added just 1.07% to the SPY. Concentrated exposure to high RS healthcare names helped drive the portfolio higher despite its relative underweight versus the benchmark.
• There were only two sectors that contributed negatively to the total return of DWTL – real estate and consumer staples, which had respective average weightings of 2.03% and 6.64% in Q2. Real estate’s total return of -12.04% caused the most drag on the portfolio at -0.31%, followed by the consumer staples sector at -0.12%. These remain weaker sectors that sit in the bottom half of the DALI rankings and are areas we would continue to underweight or avoid.
• The industrials sector was the third-largest contributor in Q2, adding 0.61% to DWTL’s total return, and had the second-highest average sector weighting of 19.80% behind tech.
• High RS materials names outpaced broad materials exposure by 5.15% on a total return basis. With an average weighting of 5.23%, industrials added 0.53% to DWTL’s performance.
• DWTL’s average exposure to energy throughout Q2 was 2.49%, which was right in line with the SPY’s average weighting of 2.80%. Despite having nearly the same amount of energy exposure as its benchmark, DWTL’s concentrated exposure to high RS energy stocks ended the quarter with a total return of 23.16%, which added 0.53% to DWTL’s performance. SPY’s broad energy exposure saw a total return of just 11.32%, adding 0.31% to the SPY’s Q2 total return, 22bps less than that of the DWTL.
• Unlike the SPY’s average weighting of 2.58%, DWTL did not have any utilities exposure throughout Q2 as our last reconstitution and rebalance was unable to identify any high momentum stocks in this space. As we’ve mentioned before, sometimes it is not about what you own, but about what you do not own. Utilities remains a low-RS sector that ranks in the basement of the DALI rankings.
• Moving into Q3, DWTL maintains its relative overweight to the industrials, technology, and consumer discretionary sectors and has exposure to all 11 broad sectors with the exception of utilities.

One of the major themes over the last couple of months has been the resurgence from growth and in particular mega cap growth. This has led the S&P 500 Index Funds group to find itself as the 5th ranked group out of the 135 groups tracked on the Asset Class Group Scores page. Another way to view this is the US Equity Core Percentile Rank which sits at a hot 97.18%, its highest reading since February of 2020. A high core equity percentile rank conveys two major messages, the core equity market is in strong standing, and there just aren’t many other asset classes that offer more than the core US equity market. For longer-term investors, this is a market where you can lean on broad equity exposure with satellite exposure to diversify the portfolio.

For context, when the core ranks this high it can pose risk for a pullback. Examining the recent rankings on the Asset Class Groups scores page, the S&P 500 Index Funds group has improved, but much of the groups that ranked above it a month ago have deteriorated. So, while it may seem like the core equity market is excessively strong, the short-term shift in leadership from value to growth has played a large role in the S&P 500 Index Funds group having such a high ranking. Most of the groups that ranked above the S&P 500 Index Funds group a month ago were groups associated with value like Financials, Basic Materials, Industrials, Small Cap Blend, and Transportation. As we’ve seen these groups deteriorate while the core market maintains its strong positioning has created an environment where the core percentile rank is at elevated levels.

The core reading will likely not remain at this elevated level, but over the last year, the core equity percentile rank has remained around the 90th percentile with the 10% of asset classes ranked above it seeing a couple of rotations. We seem to be in the middle of yet another growth/value rotation and the core keeps chugging along. This is why when there’s a strong S&P 500 Index, it is beneficial, especially for longer-term investors, to build their portfolios around the core equity market with satellite strategies surrounding it. As long as the core is strong, it’s best not to fight it and even better to take advantage.

Daily Option Ideas for July 2, 2021