The Futures / Inter Market Report

Trading the World’s Markets                            

September 14, 2007

                                            
Matthew Caruso, CMT                                  
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Stock leadership going forward

Stock markets around the world have been climbing for over 4 years now. The Dow Jones industrial average (DJIA) made a significant bottom in 2002 and again in 2003 and has since climbed to new all time highs as can be seen in figure 1. Investing in stocks for the last 3 years has been a wise decision for investors however, in order to have maximized their gains they would have had to invest in the right stocks. From 2003 until 2006 the DJIA, which is an index composed of large capitalization stocks, has underperformed compared to the Russell 2000 which is an index composed of small cap stocks. This can clearly be seen by the falling red Relative strength line in figure 2. By studying the chart in figure 2 it become evident that there has been major shift taking place in the stock market over the past year. The large capitalization DJIA stocks have begun to outperform the small cap Russell 2000 stocks, a first since this bull market has begun. The breaking of the 4 year down trendline in figure 2 will have a strong impact on stock leadership going forward.  The leadership has shifted away from small cap and the best place for an investor to put his money is now large cap stocks.

Figure 1 Chart by Metastock

Figure 2 Chart by Metastock

This does not mean that any large cap stock will outperform. Two weeks ago I analyzed the different sectors and concluded that Energy and Tech were a source of strength and Financials and Health Care were areas of weakness (http://tradesystemguru.com/content/view/83/58/). That theme continues this week. When analyzing the individual DJIA stocks the areas of strength can be seen in those same sectors in stocks like Exxon Mobile (XOM) and Honeywell (HON). The weakness can be seen in stocks such as Citigroup (chart in figure 4), Pfizer and AIG. It is important to study the relative strength of each stock compared to the DJIA as well so that you can be in the strongest stock in the strongest asset class. Figure 3 shows a chart of McDonald’s. As you can see the stock has been in a strong uptrend and its RS line in the top panel has had a bullish breakout to the upside and MCD will likely continue to be a source of leadership. On the other hand Citigroup can be seen in figure 4. This stock is near its lowest level in over a year and it has relatively been an underperformer compared to the DJIA throughout the whole bull market and will likely continue to do so. 

In conclusion, investing in large cap tech and energy stocks will likely yield market outperforming returns over the next 6 months and longer, and market underperformance is likely to continue in financial and health large and/or small cap stocks.

Figure 3 Chart by Metastock

Figure 4 Chart by Metastock
   
   
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