The Nasdaq Composite NASD has had a rocky start to 2022, with the index posting its fourth consecutive daily loss on Friday. In fact, the NASD has seen a decline in eight out of the last ten trading days. With Friday’s decline, the Composite has now pulled back over 5% from its closing value on December 27. There were a total of four 5% pullbacks in the NASD during 2021, which is right at the annual average dating back to 1972. There was only a 37-day gap between the last 5% pullback at the beginning of December and the most recent one, which is much quicker than the 92-day average gap between prior pullbacks. This also marks the swiftest 5% pullback since June 2020 at just eleven calendar days.

The recent decline has been amplified by many of the names underneath the hood of the Nasdaq Composite. Roughly 40% of the 3655 names in the index currently sit more than 50% lower than their 52-week high. While this number may seem alarming at first, we can separate those names into groupings by style as well as technical strength for a better understanding of the recent movement. The vast majority of names in the NASD are weak attribute names, with just 22% of the stocks having a TA rating of 3 or greater. The size and style breakdown shows that 77% of the index is classified in the small-cap space, and those three style boxes are the only of the nine to be at least 40% off their 52-week highs on average.

Broad domestic equity markets had quite an impressive run in 2021, with the S&P 500 Index TR.SPXX posting a total return of 28.71%. This was the third-highest annual return since the year 2000 and the ninth highest gain in any year since 1950. In the final week of Q4, the SPX marked its 70th new all-time high of the year with the close at 4793.06. There have only been two other years that have seen more ATHs, with 73 in 1954 and 77 in 1995. In fact, there have only been 25 years where the S&P 500 has printed at least 25 new ATHs.

When we focus on total returns during the final quarter of 2021, we find that the S&P 500 finished strong with a double-digit gain of 11.03%, while the Nasdaq Composite XCMP and Dow Jones Industrial Average .DINDR finished up 8.45% and 7.87%, respectively. Like what we saw take place in the second and third quarters, small-cap stocks continued to lag their large and mega-cap counterparts. Despite this relative underperformance, iShares S&P SmallCap 600 Index Fund IJR.TR and the iShares Russell 2000 ETF IWM.TR managed to finish the quarter in positive territory with respective gains of 5.56% and 2.00%. While we saw broad US market indexes hit new all-time highs in Q4, momentum-based strategies continued to struggle as they had throughout much of the year with the Dorsey Wright Technical Leaders Index TLLARGE.TR posting a total return of 5.84%, underperforming the S&P 500 Index and iShares Russell 1000 ETF IWB.TR benchmarks by -5.19% and -3.89%, respectively. In the end, elevated volatility and choppy market action caused the TLLARGE.TR Index to significantly underperform both benchmarks on a total return basis in 2021 as trends were more difficult to capture. The Dorsey Wright SmallCap Technical Leaders Index TLR2000.TR finished the fourth quarter in the black with a gain of 3.12%, outperforming the iShares Russell 2000 ETF IWM.TR by 1.12% while underperforming the iShares S&P SmallCap 600 Index Fund IJR.TR by -2.44% in Q4. When all was said and done in 2021, the TL2000.TR Index posted a gain of 20.65%, outpacing the IWM benchmark by over 6% while underperforming the IJR benchmark by -5.93%.

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 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 and the Dorsey Wright SmallCap Technical Leaders Index, are not immune to periods of underperformance, however, we have found that RS has tended to rebound out of these laggard periods, providing, at times, consistent and robust returns. As a result of shifting strength, we saw 46 changes (out of 100 holdings) in the TLLARGE.TR with this most reconstitution and 89 changes (out of 200 holdings) in TLR2000.TR, repositioning both portfolios toward areas of leadership.

Below you'll find an update to the changes made in both strategies with the most recent index reconstitution. Keep in mind that positions that have been removed no longer maintain characteristics of superior Relative Strength. Meanwhile, additions have improved to a place of leadership and may even be ideas to consider on an individual stock basis.

Dorsey Wright Technical Leaders Index Process

The stock-selection process behind the Dorsey Wright Technical Leaders Index 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 46 stocks and added 46 new stocks, which we've compiled in the tables below. One of the more interesting observations is the "Average Technical Attribute Reading" for the two lists. As of 1/5/2022, the 46 stocks added to the strategy this quarter have an average technical attribute rating of 4.61. The 46 stocks that were removed, however, have a weaker average attribute rating of 1.87. 

Dorsey Wright Technical Leaders Index Changes

Dorsey Wright Technical Leaders Index Stats:

• Out of the 46 stocks added, the industrials sector accounted for the most at 28.3% followed by the technology sector at 17.4%. Financials made up 13%.

• Of the 46 stocks removed, Upstart Holdings, Inc. UPST was the worst-performing in Q4 with a loss of -52.19%, followed by DocuSign Inc. DOCU, down -40.83%.

• Technology accounted for the majority (26.1%) of the removals this quarter, followed by the healthcare sector (23.9%).

• Of the 46 new additions to the strategy this quarter, 34 are perfect 5 for 5'ers while 44 are high attribute names (3, 4, and 5'ers). With the exception of Salesforce.com, Inc. CRM and Innovative Industrial Properties, Inc. IIPR, all newly added names are trading in overall positive trends (above their respective bullish support lines).

Dorsey Wright SmallCap Technical Leaders Index Process

The stock-selection process behind the Dorsey Wright SmallCap Technical Leaders Index is quite simple, yet robust. Every quarter, we apply the Relative Strength process to compare approximately 2,000 US-listed small-cap stocks and select the strongest 200 names. The quarterly reconstitution process's primary goal is to consistently weed out the relatively weak names and realign the portfolio toward strength. With this most recent reconstitution and rebalance, we removed 89 stocks and added 89 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 1/5/2022, the 89 stocks added to the strategy this quarter have an average technical attribute rating of 4.40. The 89 stocks that were removed, however, have a weaker average attribute rating of 2.10.

Dorsey Wright SmallCap Technical Leaders Index Changes

Dorsey Wright SmallCap Technical Leaders Index Stats: 

• Out of the 89 stocks added, the cyclicals sector accounted for the most additions at 20.2%, followed by industrials at 19.1%.

• Of the 89 stocks removed, Amyris Inc. AMRS was the worst-performing in Q4 with a loss of -60.60%, followed by Clearside Biomedical CLSD, down -54.17%.

• Healthcare accounted for the majority (27.3%) of the removals this quarter, followed by consumer cyclicals (20.5%) and industrials (12.5%).

• Of the 89 new additions to the strategy this quarter, 57 are perfect 5 for 5'ers while 84 are high attribute names (3, 4, and 5'ers).

The start of 2022 has seen a notable surge in strength from value areas of the market as rates and commodity prices have swiftly moved higher. One of the major sectors affected by this has been technology, which was touched on in yesterday’s Fund Score Overview. Energy and financials have been the two sectors that have benefitted the most to start the year. Utilities, consumer staples, and real estate are also areas that have had strong upticks so far this year. This has had a clear effect on the size & styles rankings. The groups with the worst score directions on the US Styles view are mid-cap growth, small-cap growth, micro-caps, and large-cap growth while we see value styles leading the way in terms of average scores. The S&P 500 Index Funds group firmly remains in the leadership role and it should be noted that many of the mega-cap growth stock names are still technically strong from a long-term perspective despite large-cap growth and technology weakening.

Low volatility equities have perked up after a long stretch of being dormant and the group has quietly moved up the rankings over the past few weeks. The group has an acceptable average score of 3.33 with a positive score direction of 0.45, one of the highest on the Asset Class Group Scores page. The group is at its highest level since February of 2020. One of the main drivers behind the move has been the strength of utilities and staples over the past month which make up roughly 40% of the underlying sector exposure for the Invesco S&P 500 Low Volatility ETF (SPLV). SPLV currently has a fund score of 3.52 along with a positive score direction of 1.02.

Large caps aren’t the only area to see their low volatility equities do well, small and mid-caps are also participating. The Invesco S&P SmallCap Low Volatility ETF (XSLV) possesses a fund score of 3.71 and a positive score direction of 0.91. Most notably, the fund broke a spread quadruple top to reach a new all-time high and is trading on seven consecutive buy signals. After a long period of relative weakness, the pick-up in strength in the low volatility shouldn’t be ignored especially given the current macroeconomic backdrop that seems to favor higher rates. When low volatility equities have acceptable levels of relative strength they can offer a unique way to add diversification to your clients' portfolios.

Daily Option Ideas for January 7, 2022