More Bullish Evidence and the Growth/Value Message

Strengthened ratios drive stock/bond composite and ACWI to record-high levels (Ned Davis Research).

By Tim Hayes

Key Takeaways

  • Strengthened weight of the evidence has sent our Stock/Bond Composite to higher highs.
  • ACWIGrowth/Value Ratio and our Risk-On/Risk-Off Ratio have continued to confirm the ACWI’s record highs.
  • Indicator evidence and relative performance trends will continue to tell us if the current healthy conditions will remain intact or deteriorate, as in 2021-2022

Market conditions haven’t been so healthy since mid-2021. Will they remain this way or will they start to deteriorate like they did later that year?

The answer will be provided by the Stock/ Bond Composite below. Used in our Global Balanced Account Model, half of its weight is based on price-based internal factors and the other half is based on non-price external factors. The composite has now jumped to 89%, a level last seen 21 months ago.

Since the market bottom in October 2022, the composite has been trending upward with higher highs and higher lows, much as it did after the lows in March 2020. By mid-2021 the indicator mix was as bullish as it could get. 

But as the year progressed, divergences developed, momentum waned, credit spreads widened, the economic outlook worsened and earnings confidence deteriorated. The composite trended downward with lower highs and lower lows, reaching its bearish mode in January. That’s when we started cutting the equity allocation in the developing bear market.

By September, the composite had returned to the same market-bottom level reached in 2020, again entering an uptrend as the weight of the bullish evidence increased. And now that buy signals have been generated by the composite’s indicators based on sentiment and the breadth of earnings estimate revisions, the composite has risen to another higher high. As a result, we expect that with its May update, the model will call for allocations that are one percentage point away from our recommended weightings of 70% stocks (maximum overweight), 20% bonds (under- weight) and 10% cash (market weight).

While continuing to pay close attention to the model, we will watch for other developments that warned of trouble as 2021 progressed – a deteriorating Rally Watch aggregate that reached 0% by November of that year, a rising number of warnings from Bear Watch indicators, earnings beat rates with negative momentum, and a divergent Risk-On/Risk-Off Ratio with worsening breadth.

But there was something else happening in late 2021 that would again be a warning, evident in the chart below. The ratio of the ACWI Growth Index to the ACWI Value Index failed to reach a new high and diverged from the benchmark, dropping below its 200-day moving average.

The chart’s mode boxes indicate that when the ratio has been above its 200-day moving average since 1998 and over the past five years, the ACWI has risen at a double-digit pace, whereas it has declined when the ratio has been below the smoothing. Considering the ACWI’s positive correlation with the ratio (bottom clip), it would be a positive sign if the ratio would remain above its smoothing and continue to reach new highs, inconsistent with a developing bear market.

The ACWI Growth and Value indices are now included in both our Benchmark Returns report and our report comparing benchmark trends. The chart below shows the ACWI Growth Index chart from the latter report, with the bottom clip indicating that the spread between the 50-day and 200-day moving averages is nine percentage points. That exceeds the spreads for the ACWI, the MSCI U.S. Index, and the other six indices in our regional framework.

According to MSCI, the Growth Index constituents are based on short-term and long-term forward earnings growth, current internal growth and the long-term trends of earnings and sales growth. The “magnificent seven” U.S. mega caps account for 33% of the index’s weight while the U.S. weight in the Growth Index is 63%, the same as the U.S. weight in the ACWI. The weights are 5% for stocks in Japan, 3% for stocks in France, the U.K. and China, and 23% for others in the 47-market ACWI. 

Contrasting the Growth Index out performance, the relative strength line of the ACWI Value Index has reached its lowest levels since 2021 (below, bottom clip). Close to its weight in the ACWI and the Growth Index, the U.S. accounts for 64% of the Value Index weight, followed by Japan’s weight of 6% and the U.K.’s weight of 4%. France and China each account for 3% of the weight, while all others carry the remaining 21% of the weight. MSCI identifies the Value Index components based on their book value yields, forward earnings yields and dividend yields.

Breaking down the style indices by sector weights, we can see that nearly half of the Value Index weight is attributable to Financials (24%), Health Care (13%) and Industrials (12%), while half of the Growth Index weight is carried by Information Technology (36%) and Consumer Discretionary (14%).

The two Growth sectors have relative strength lines that are components of the NDR Risk- On Index. Like their influences on the ACWI Growth Index, the Tech sector’s outperformance has been positive for the Risk-On Index (chart below) while the performance of the Consumer Discretionary sector has been negative (chart above).

But in the same way that the discretionary sector’s impact has been insufficient to drive the Growth Index out of its uptrend, it hasn’t been enough to halt the Risk-On Index’s ascent to bull market highs. With the Risk-On Index trending higher as the Risk-Off Index has languished, the Risk-On/Risk-Off Ratio has been rising to new records (chart above).

The current trends stand in contrast to the bear of 2022, when Tech and Discretionary were both underperforming and the Risk-Off Index was trending lower with a descending RO/RO Ratio. As shown in the second chart in this article, the ACWI Growth/Value Ratio dropped below its 200-day smoothing as the year got started and remained below the descending smoothing throughout the bear market.

Recollections of 2021-2022 give us a lot to watch. But a similar slide will be unlikely
if bullish tape conditions and a favorable macro backdrop keep the Stock/Bond Composite at current or higher levels, together with the ACWI Growth/Value Ratio and our Risk-On/Risk-Off Ratio continuing to confirm the ACWI’s record highs. The weight of the indicator evidence and relative performance trends will continue to tell us if market conditions are deteriorating or maintaining their current healthy state.

Anoop Naath, CFA, has provided research for this report. 

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