It’s time for a break. At least that’s what a stock market indicator says. The Relative Strength Index for the Dow Jones Industrial Average (DJIA) has stuck its head into oversold territory after a rocketing ascent following the election. And now, on the daily chart, there’s a symmetrical triangle, indicating another explosive move ahead.
But that’s just on the Dow 30 graph. You don’t see quite the same picture for the S&P 500 (SPX). Oh, the broader market benchmark soared too, just not as dramatically. In fact, SPX still hasn’t taken out its 2015 highs—yet.
Two things to keep in mind here. First, the election reaction was clearly concentrated in the Dow’s “big blues”—mega large-cap stocks. Second, markets rarely move in straight lines. Reactions and counter-cycles are inevitable. In fact, for most technical analysts, they’re welcomed. Experience shows that a major trend is more sustainable when there are pauses to allow new participants to get on board while permitting existing investors to take some money away.
Is there, then, a reactive selloff due in the Dow? Probably. And are these stocks headed for a prolonged ride upward afterwards? Well, that’s a trickier question.
We can say one thing with certainty: Investors are in a mood to take on more risk now. There are several indicators pointing to this conclusion.
Two exchange traded funds (ETFs) measure broad market sentiment toward risk. The PowerShares S&P 500 Low Volatility ETF (NYSE Arca: SPLV), which had been a market darling during last year’s equity stall, takes 100 stocks with the lowest daily volatility out of SPX. That’s the “low-risk” play. Taking the opposite tack is the PowerShares S&P High Beta ETF (NYSE Arca: SPHB), which culls SPX for 100 issues with the highest beta, or market risk. Look what’s happened to the SPHB/SPLV ratio recently:
Risk appetite has been on an upswing since July. It seems the risk switch was turned to “on” this summer and it really didn’t matter who was elected. The ratio tells us that investors were, and are, keen to get their stock on.
Not just any stock, though. Since the election results were tallied, there’s been a bunch of alpha hunting going on. You can see that reflected in the S&P 500 Implied Correlation Index (KCJ) below:
KCJ gauges the relative expense of SPX options by metering the correlation between index contracts and the prices of options on the index’s 50 largest components. See how the correlation fell after the election? That means there’s divergent expectations and, therefore, room for alpha—negative or positive—to be obtained.
So, what stocks are likely to be alpha earners?
Keep tuned. We’ll cover that in our next column.
Brad Zigler is REP./WealthManagement's Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.