Isolating the participation of growth and value names, we can see that there’s been a clear culprit behind the recent slowdown. Given recent indicator movement, how can we combine momentum and value?
While markets have been steady over the last several months, participation within the market has not. Over 70% of large cap stocks traded on a buy signal around a month ago, as measured by the bullish percent for large caps (^BPLCAP), but that indicator has fallen by over 20%, as less than 50% of those stocks now trade on a buy signal. However, the decline in participation hasn’t come across the board. Isolating the participation of growth and value names, we can see that there’s been a clear culprit behind the recent slowdown.
A Growth Driven Participation Decline
The bullish percent for large cap growth stocks (^BPLCG) peaked at 74% in August, which was the highest it had climbed in over a year. Since then, the indicator reversed into a column of Os, moving significantly lower to its current levels just above 40%. Conversely, the bullish percent for large cap value stocks (^BPLCV) peaked at 68% in August and only just reversed back into a column of Os, with it currently at 62%. Said differently, a third of growth stocks have moved to a sell signal over the last month while only 6% of value stocks have done so. Consequently, the recent decline in participation has come almost exclusively from growth areas while value stocks have primarily remained steady. For those worried that participation in the market, especially growth names, is flashing yellow lights (as we mention here), then it could make sense to pivot more allocation over to value.
The Intersection of Value and Momentum
For investors considering that shift, the challenge becomes determining how to implement it. Momentum investors and value investors are often viewed as polar opposites. Momentum investors buy stocks that are appreciating (showing positive momentum), while value investors generally buy stocks with depleted (undervalued) prices. Each approach looks at different calculations to arrive at target stocks, but they often function on different time horizons.
Of course, momentum and value investing also have some similarities. Both investment approaches seek to hold stocks they expect to appreciate at some point in the future. Otherwise, what is the point of investing? When implemented successfully, both approaches have a repeatable process that can be used to identify target securities. We are partial to momentum investing here at Nasdaq Dorsey Wright since it is the backbone of our investment process. We understand (perhaps better than most) that focusing on momentum does not work every time, but it can work over time when implemented consistently. Value investing often functions the same way even though the approach is different. Some periods work well for value investing, and others do not.
Currently, value securities could provide exposure to areas of the market that have held up relatively well during the recent deterioration in participation, but investors do not necessarily need to abandon momentum altogether. In fact, one of the more interesting areas of the market today may be the intersection of those two factors, focusing on value stocks that are also demonstrating strong relative strength. Combining the two can offer a way to maintain exposure to stocks with improving price trends while tilting toward the portion of the market that has proven more resilient in recent weeks. Additionally, the success of value and momentum often occurs at different times, as these two return streams are also typically inversely correlated with one another (source: Value and Momentum Everywhere by Clifford Asness et al.). Historically, combining the two factors together has created a more consistent return profile over time, and it has the potential to do so again in the future, depending on market conditions.
Both Factors in Action
The First Trust Dorsey Wright Momentum & Value ETF (DVLU) seeks to follow a systematic process that combines aspects of both factors into a single approach tracking our Momentum Plus Value Index. That process takes a broad inventory of US large and mid-cap equities and compares them to the market using relative strength (momentum). Once we determine which stocks pass the initial RS screen, we then rank them based on a composite value score that accounts for price-to-earnings, price-to-sales, price-to-book, and price-to-cash flow. The 50 securities with the highest value score at each quarterly evaluation are selected as the index constituents.
This process has led to positive technical development from DVLU this year. Over the last year, DVLU has completed three consecutive buy signals and has traded firmly in a positive trend. While it pulled back in March of this year, the fund has risen more 16% since the start of April, outpacing the iShares S&P 500 Value ETF (IVE) by almost 7%. Recent action has seen the fund pull back slightly again, leaving it in slightly oversold territory with an OBOS reading around -50%. Despite that, it still sits in constructive territory with a fund score of 5.26, which is nearly a full point higher than the US Large Cap Value group on the ACGS page.
Disclosures:
This article is intended only for financial professional use only. Not Intended for retail investors.
Click here for more information from Invesco on the First Trust Nasdaq Dorsey Wright Momentum & Value ETF (DVLU): https://www.ftportfolios.com/Retail/Etf/EtfHoldings.aspx?Ticker=DVLU
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