Weekly Barometer: Market At Key Inflection Point With Momentum Breaking Down

jdhenning
Summary
  • The weekly barometer of top portfolios shows Momentum continues to dominate the sample of Fundamental, Forensic, Value, and Anomaly portfolio strategies into 2019.
  • This Fourth Quarter 2018 is the weakest quarter relative to earnings expectations in 7+ years according to BofAML Quant Analysis.
  • Momentum Gauge chart showing most negative momentum acceleration conditions since prior to the October downturn.
  • The Premium Portfolio is up over 14% heavily weighted toward momentum stocks with 18 stocks having gained well over 10% YTD.

The Portfolio Barometer

This article continues the weekly update on the conditions I see in the market based on the types of portfolios that are outperforming or absent from the list of top performing stocks. Portfolio strategies may experience the same autocorrelation that sustains strong price movements among momentum stocks, both positively and negatively. Using an inductive portfolio model approach that goes where the types of returns in the market are strongest, I monitor different fundamental, value, momentum, forensic, and anomaly portfolios from financial research to create a portfolio barometer.

I also use this inductive portfolio approach to select the 20 stocks in the Premium Portfolio from my membership service that draws from a wide range of different models in the financial literature.

The top gains this week across all the portfolio types appear to be primarily based on the strength of momentum and the Russell 3000 anomaly portfolios. The lack of representation of stocks from the fundamental, value, and forensic portfolios this week is in stark contrast to the positive run through January. This article also expands on last week’s results as to what these signals may mean for short-term trading.

This list forms a type of market barometer you can use that may signal what selection strategies are working best and what is changing in the market.

Weekly – Top Performing Stocks from all the Active Portfolios
Portfolio Symbol Current Weekly Monthly Price
Breakout Stock Week 41.2018     (AMRS) 3.28% 66.08% 40.40% 5.63
Russell 3000 Top 10 – July 2018 AMRS 3.28% 66.08% 40.40% 5.63
Russell 3000 Top 20 – July 2018 AMRS 3.28% 66.08% 40.40% 5.63
Forensic Negative Portfolio – December 2017 (STON) 5.98% 36.17% 20.75% 3.20
Russell 3000 Top 10 – July 2018 (ZFGN) 12.94% 13.74% -3.26% 5.05
Russell 3000 Top 20 – July 2018 ZFGN 12.94% 13.74% -3.26% 5.05
Breakout Stock Week 50.2018 (SBGL) 6.15% 13.12% 31.97% 3.88
Breakout Stock Week 49.2018 (AMSC) 4.16% 10.64% 23.06% 14.46
Breakout Stock Week 16.2018 AMSC 4.16% 10.64% 23.06% 14.46
Breakout Stock Week 6.2018 (SRNE) 2.73% 9.71% -14.07% 2.26
Breakout Stock Week 45.2018 (VBIV) 5.78% 9.58% 15.82% 1.83
Breakout Stock Week 5.2019 (TTGT) 8.12% 9.31% 29.18% 15.85
Breakout Stock Week 29.2018 (ARDX) 2.21% 9.05% -2.14% 2.29
Russell 3000 Top 20 – July 2018 (HEAR) 1.55% 7.25% 1.14% 15.97
Breakout Stock Week 3.2018 (CLBS) 1.56% 7.19% 12.50% 5.22
Breakout Stock Week 31.2018 (SORL) 1.75% 7.01% 10.27% 2.90
Breakout Stock Week 25.2018 (AQXP) 2.08% 6.52% 0.41% 2.45
Breakout Stock Week 5.2018 (CYRX) 1.18% 6.39% 26.67% 11.16
Bounce-Lag Momentum Week 46.2018 (DIN) 0.30% 6.35% 5.87% 81.11
Breakout Stock Week 32.2018 (RUBI) 2.16% 5.83% 15.40% 4.72
Breakout Stock Week 21.2018 RUBI 2.16% 5.83% 15.40% 4.72
Breakout Stock Week 4.2019 (DSKE) 1.63% 5.76% 7.04% 4.41
Breakout Stock Week 34.2018 (ANGO) 1.56% 5.17% 5.57% 22.19
Breakout Stock Week 37.2018 (ENZ) 1.02% 5.05% 30.79% 3.95

Of the 19 stocks listed above from different active portfolios that delivered better than 5% this past week (through the writing of this article), only three stocks, StonMor Partners (STON), Zafgen, Inc (ZFGN), and Turtle Beach Corporation (HEAR) did not come from a Momentum-based stock portfolio. This tells me that the market is continuing to discount or disregard top emphasis toward fundamentals-based selection models and is much more attracted to price momentum characteristics and behavior. Though these conditions do not have to be mutually exclusive, the small cap momentum selections are still outperforming portfolios based exclusively on strong fundamental and value characteristics.

This may reflect the condition of poor market health that has not yet returned to a focus on fundamentals and value where outperforming returns have been more highly correlated in the past. My ongoing barometer, based on the chi-square statistical tests conducted on 2018 key performance variables, continues to show that alternative selection models are more dominant under current conditions. Detailed descriptions of each of the portfolio types are available in the links in the table and in the explanation of the table in the section below.

Market Conditions

The recent quantitative strategy analysis from BofA Merrill Lynch confirms this weaker market condition where fundamentals and earnings are failing to deliver. So far in to the fourth quarter 2018 earnings season with 73% of firms reported, we are seeing the fewest number of earnings beats since second quarter 2011.

On the positive side the market sectors that are showing positive revisions of both earnings and sales are the Industrials and the Health Care sectors. Healthcare stocks are one of the largest components of the momentum portfolio selections.

As a reminder, here is this large divergence chart I posted last week that still strongly applies into early February.(Source: Zero Hedge)

The current disconnect between the S&P 500 index and the forward EPS for stocks in the S&P 500 illustrated above also suggests a certain degree of frothy momentum type behavior. This supports the portfolio barometer showing momentum and adverse forensic stocks continuing to outperform since December.

Using the Bernstein analysis chart below, I show some theoretical ranges of stock selection models that I am continuing to test. The possibility exists that momentum stock selection is the most effective strategy during high volatility “frothy market” periods where standard fundamental and value models are unable to differentiate from market indexes.

This is a working theory that I continue to test with my stock portfolio barometer across the different models from the financial literature to see what develops. The overly generalized organization of stock portfolio performance into 3 categories (frothy, stable, oversold) serves mainly to help explain my observation that fundamental selection models increasingly failed to deliver differentiated market returns throughout 2018: Funds And Fundamentals Breaking Down: What Are Your Best Alternatives For 2019?

So if we are in the frothy market top of the market where momentum models dominate, what should we look for? I submit that a strong decline in positive momentum that rivals Week 39 last year in the final week of September before the October correction may be a fairly good warning signal.

The Momentum Gauge control chart shows the highest negative momentum level in over a month as well as the steepest drop in positive momentum since the last week of September 2018.

These indicators may further support the Bernstein analysis charted above of high vs. low momentum stocks by sector P/E levels and the possibility we are nearing a correction back toward fundamental strategies. We know that fundamental models work very well during stable markets with rational valuations and a lack of central bank external effects to alter market liquidity conditions.

Explaining the Table of Stocks by Portfolio

First, the stocks from portfolios highlighted in yellow are classified as momentum-based stock selections. These are stocks that have strong characteristics of high volatility, money flow, strong positive technical signals, and an increasing level of positive sentiment building for momentum gains. They are not necessarily good value or fundamentals-based stocks, but ones expected to deliver quick short-term gains over regular periods as their technical parameters move through optimal trading ranges.

Second, the stocks from portfolios highlighted in green come from the Forensic Negative portfolios with generally accepted negative fundamental characteristics. These stocks score poorly on three academic forensic models covering 22 different financial ratios and criteria.

My working theory is that stocks that achieve high adverse scores on all three forensic algorithms may be much more dependent on momentum and investor sentiment for price performance than on fundamental financial performance. This dependency on weaker fundamental financial data makes the firms more susceptible to larger price fluctuations and potentially lower annual returns.

Third, the stocks from portfolios highlighted in red come from the different Russell Index Anomaly portfolios that try to exploit the annual index reconstitution effects documented in the literature. These stocks by design are small- to mid-cap stocks with potential for high momentum volatility, but not necessarily selected for momentum characteristics over fundamental and value-based criteria.

Fourth, the Piotroski-Graham enhanced portfolios in gray leverage one of the top value portfolios known to outperform many other value portfolios in published studies. The Graham enhancement and other modifications make this a top performing portfolio for long-term buy/hold stock portfolios.

Lastly, the Forensic Positive portfolios shown in blue represent the best fundamental scores from three different forensic algorithms that apply 22 different financial tests. Potentially these strong financial characteristics produce strong long-term value returns in buy/hold models that I am testing.

This list is not the entirely comprehensive list from my top stock tracking board but represents the top stocks through this point in time today.

These results following on last week’s article support the continuation of momentum and technical models to generate more positive returns in the short term. Also Seeking Alpha recently released a new feature that lets you monitor your own stock’s momentum here.

What condition is the market in?

If these stocks and portfolios can serve as sort of weekly barometer of market conditions, what condition is the market in?

I submit based on my ongoing research into the Fed QT activity, VIX anomaly, and patterns of the FANG+ stocks, that investors are currently keying on different variables like money flow, liquidity, and volatility for market decisions. The latest announcement from the Federal Reserve to move cautiously with the quantitative tightening activity provided a large positive relief reaction that has seen the market breaking out through today.

Monitoring the $3.6 trillion proxy of the markets known as the NYSE FANG+ Index comprising 10 stocks provides strong indicators of where the market is headed. The 10 stocks that comprise the NYSE FANG+ Index: Apple (AAPL), Alibaba (BABA), Amazon (AMZN), Baidu (BIDU), Facebook (FB), Google (GOOG) (GOOGL), Netflix (NFLX), Nvidia (NVDA), Tesla (TSLA), and Twitter (TWTR).

The latest update is as follows:

(Source: FinViz) MicroSectors FANG+ -3X Invrs Lvrgd ETN (FNGD)

(Source: FinViz) BMO REX MicroSector FANG+ Index 3X Leveraged ETN (FNGU)

Based on these FANG+ stocks as a leveraged market proxy we are seeing significant early signs of a potential market reversal. The bearish inverse chart FNGD is signalling an early price reversal toward new bearish breakout conditions if this trend can hold and the indicators move into positive levels over the coming days.

I will provide another update on this barometer later next week to see what changes in top-performing stocks and portfolio types are delivering gains into a very volatile market.

All the best!

JD Henning, PhD, MBA, CFE, CAMS