Research Excerpts

Positioning Portfolios For The 4th Quarter

Posted on: Saturday, September 15th, 2018

Part of what our research does to help subscribers be properly positioned in the stock market is to fine-tune their core holdings, taking advantage of relative performance trends in the small, mid, and large cap segments of the market.  By modifying the core holdings within a portfolio to take advantage of these internal changes in relative performance, investors can potentially pick up some alpha in a more risk averse way — without changing the size of the core allocation.

Exactly 4 months ago, in our May 14th Keys To This Week report (access requires subscription) we pointed out an emerging breakout higher in the small cap Russell 2000 and said it targeted a rise to 1750.

Here is the chart from that report.

Russell 2000 daily: August 2017 to May 18th

The next chart, an updated version of the one above, shows that RUT traded as high as 1742 on an intraday basis on August 31st, essentially meeting our target,  and has since drifted lower.

Russell 2000 daily: August 2017 to September 14th

When a stock or an index gets this close to a price target and then stalls or reverses direction, we 1) assume that the directional implications of the breakout have been met and, as a result, 2) expect to see at least a minor decline as profit taking takes place.  Accordingly, this chart suggests this may not a particularly good time to to be adding exposure to the small cap space.

The next chart is a little more complicated, but simply shows that the Russell 2000 is also currently vulnerable to upcoming relative underperformance versus the overall market, between and year end.

Relative Performance of S&P 600 vs. S&P 1500 since 2015

It simply shows that the iShares S&P Small Cap 600 Index ETF (IJR,) is retracting from quarterly overbought extremes versus the the iShares S&P 1500 Index Fund ETF (ITOT), and that previous instances of this led every multi-month period of relative underperformance by Small Cap versus the overall market during this period (red vertical highlights).

This chart not only suggests that this is not a good time to chase the small cap space on an outright basis, but also that small cap is poised to underperform the overall market during the 4th Quarter. 

In a case like this, we are looking at similar charts and metrics to determine whether to shade core holdings in portfolios away from small cap, and toward either the mid cap or large cap space, as at least one of these three is always outperforming the overall market.  By selecting the right one(s) at the right time, and rotating them throughout the year as necessary, we can add some performance to portfolios without changing the actual size of the investment.

 

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