You don’t win today’s game with yesterday’s home run

January 8, 2021  |  Michael Reilly

“You don’t win today’s game with yesterday’s home run”.

-Babe Ruth

Regardless of how successful your portfolio was or was not in 2020, it’s in the books. It’s over; time to move on.

So rather than spending considerable time and energy talking about 2020, today, I’m going to share what I’m seeing right now.

I’m not talking about looking at the indexes either, I’m talking about something much more important, something much more useful.

Investors can gain important and potentially profitable insight from looking beyond the indexes, by paying attention to some of the most important relative strength and inter-market relationships in the markets today.

It’s the age old question – should investors be looking for stocks to buy or stocks to sell?

The best way I know to answer that all-important question is by starting at the top and analyzing inter-market relationships at the Asset Class level – comparing the strength of stocks to their major alternatives.

Stocks vs. Fixed Income and Stocks vs. Gold

Let’s dig in. The first chart we’re going to look at is the relationship between T-Bonds and the S&P 500 (TLT/SPY).  It’s Growth vs. Safety.

If stocks are under pressure, what would that look like?

Well, I’d expect Bonds would be outperforming stocks. Bond prices would rise not only on an absolute basis but on a relative basis -vs- stocks.

We’d see that flight to safety here on this relative strength chart comparing T-Bonds vs. Stocks.

The line chart would be spiking higher – as it did in February.

But that’s not what’s happening, The line chart is moving down, not up. T-Bonds relative to the growth stocks of the S&P are near all-time lows. This relationship screams risk-on not risk-off.

The next ratio I find important to look at from a macro perspective is Gold vs. Stocks (GLD/SPY).

Gold is another major alternative to stocks and, similar to Bonds, is considered a hedge against stock market volatility. So, again, if stocks were under pressure, I’d expect the relationship to favor Gold over stocks – just like it did in February…

I’m not seeing this ratio spike, indicating the relative strength between Gold and Stocks favoring Gold. No, quite the opposite, Gold is closer to it’s lows on a relative basis.

Thus far, the weight of the evidence is in favor of stock ownership over Bonds and Gold.

Here’s another important relationship in the currency markets.

This isn’t one that I see talked about often enough, however, when it comes to analyzing the state of markets, it can be just as as important as some of these other RS relationships we analyze.

The Aussie Dollar vs Japanese Yen. Consider the Aussie Dollar more as the ‘growth trade’, think China, Emerging Markets. While the Yen as the ‘defensive play’, where money goes to hideout.

If stocks are under pressure, the Yen is likely outperforming the Aussie Dollar, like it did back in February. 

However, what I see is the Yen moving lower relative to the Aussie Dollar. There’s nothing defensive about that!

Ok, so I just shared three important ratio charts comparing asset class strength, that all – as of now – favor investing in stocks over Bonds or Gold.

Now let’s dive into a few relative strength relationships between markets and sectors.

Here’s one comparing Consumer Staples stocks to the overall market – the S&P 500.  I wrote about this in depth last week – you can read more about that here.

So, here’s the thing, Staples are things we’ll consume regardless of how bad the economy is – we’re still going to wash our dishes and brush our teeth. If stocks are under pressure and selling off, we’re going to see Consumer Staples, the more defensive stocks, outperform the S&P on a restive basis – like we did back in February.

But we’re not seeing that, we’re getting new lows in the relationship between Staples and the S&P. It’s growth over defense. That’s important information to investors.

Here’s a similar spin that reinforces what I’m seeing between Staples vs. the S&P. Here, I’m looking at High Beta stocks vs. Low Volatility stocks.

This is the classic growth vs. defensive stock story.

New highs in Beta over Low Volatility is consistent with what we are seeing in so many of these relative strength relationships.. stocks are moving higher.. So this is confirmation from Beta over low volume in what we are seeing in the S&P 500 index.

So again, you can see the value of looking at the “markets” not from an index perspective, but from a different lens. The lens of relative strength relationships.

The last chart we’ll hit on today is a sector chart comparing Consumer Discretionary stocks to Consumer Staples or Growth over Defense.

This is one of my favorite ratios. When looking at this ratio what we’re really looking at is the long-only community – think mutual funds that are required to stay fully invested.

Most mutual fund managers have two choices – invest in discretionaries stocks looking for growth or hide out in consumer staples stocks and play defense.

It’s comparing Discretionaries: Auto’s, Retailers and Home builders vs. Staples, the things we’re going to buy no matter what the economy looks like.

And today, right now, Consumer Discretionary stocks are at all-time highs relative to Consumer Staples – this is consistent with higher stock prices.

Here are my parting words of advice for the day and the new year:

Forget the news, forget the Fed and Trump and everything else; watch these risk assets, watch these important inter-market relationships. If markets are going to rollover, we’ll see it here.

We’re watching some of the biggest players in the world and if they’re hiding out, we’re going to spot it in these relationships.

Next week I’m going to dig into some interesting developments in the Financial sector that I’ve uncovered – hint, one of the industry groups in financials is breaking out.

Until next week, invest wisely.

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