Nasdaq Dorsey Wright Year End Review and What to Watch for in 2022
Nasdaq Dorsey Wright focuses on investment strategies and methodologies based on technical analysis and relative strength investing, specifically, the point and figure method. In a recent webinar, Jay Gragnani, Head of Research, and John Lewis, CMT - Senior Portfolio Manager, shared their views on the year’s end and what lies ahead for 2022. They addressed how leadership trends across major asset classes and U.S. equity sectors have adapted to pressures such as rising inflation. They also explored some key areas of the market that have shown strong growth potential in 2022.
Going back to 1950, the beginning of November to the end of April is historically a six-month strong period for the markets, Gragnani explained. Most of the returns come during this time of the year. Moreover, December tends to be the second-best performing month for the S&P 500. Afterward, from May to November, the market goes into a weak six-month period.
These seasons make a difference when it comes to investment. In 1950, a $10,000 buy and hold investment in the Dow Jones Industrial Average would be worth just over $1 million today. If the investor was in the market only for the seasonably strong period, the investment would have grown almost as much. However, if the investor was in the market for only the seasonably weak period, the investment would have barely grown.
Nasdaq Dorsey Wright takes the thousand largest stocks, runs them against the broad market, separates them into four buckets and reconstitutes monthly. Importantly, Lewis pointed out that this methodology works over long periods of time but not necessarily in the short term.
Insights From Point and Figure Charts
The S&P 500 has been in a strong uptrend since the market bottomed out in spring 2020. That uptrend has pushed to new highs with intermittent pullbacks as new COVID-19 variants emerged and concerns grew about the slowing economy and inflation.
According to Nasdaq Dorsey Wright’s 20- and 50-point and figure charts, the uptrend is still intact. At the beginning of December, the S&P 500 pulled back to support levels but then reversed, giving a new point and figure buy signal on the 20-point chart. That stance is unlikely to shift until a larger topping pattern or unexpected news emerges.
Another indicator is the percentage of stocks in the S&P 500 that are trading above their own point and figure trend line, a concept that is similar to price vs. 200-day moving average. If a stock is trading above the trend line, it is considered a relatively strong security. About 72% of the stocks in the S&P 500 are now trading above their point and figure trend line.
The relative strength and momentum methodology is a powerful tool that works across multiple asset classes and helps investors constantly push their portfolio toward areas of strength. As an example, Lewis compared Home Depot to the broad market, represented by the S&P 500 equal-weighted index. He created a ratio line by dividing Home Depot’s share price by the price of the benchmark. When the ratio is rising, Home Depot is doing better than the market and vice versa. A column of x’s on the point and figure chart means the ratio is rising on a shorter-term basis, and a column of o’s means it is going down. Buy and sell signals are highlighted in green and red. When the chart shows repetitive buy signals on a rising ratio line, the stock is constantly pushing to new relative highs over time.
The Dynamic Asset Level Investing Model
Nasdaq Dorsey Wright’s Dynamic Asset Level Investing (DALI) model can help investors determine which asset classes or sectors they should overweight or underweight. DALI compares six broad asset classes, evaluates the price and ranks them on a relative strength basis.
U.S. equities, which tends to be a growth-oriented asset class, has ranked #1 the most of the past 12 years. It was in the top slot from 2016 until 2020 when it fell out of favor for a few months and then recaptured its position in August 2020. In the past couple years, it has been ranked #1 about 75% of the days. From 2010 to 2019, it was ranked #1 about 90% of the days. Commodities currently ranks #2, and international equities ranks #3. The more defensive, lower-beta asset classes —fixed income, cash and currencies—are ranked #4, #5 and #6 respectively.
On the other hand, 2000 to 2010 was dubbed “the lost decade” for U.S. equities. An investment in the S&P 500 at the end of 1999 that was held until the end of 2009 would have yielded no return. That said, there were four 20% moves—two up and two down—during that period. Moreover, there was opportunity elsewhere. International equities were ranked #1 about 51% of the time, and emerging markets and commodities were strong.
DALI shows that if 100% of the portfolio was invested in the #1 ranked asset class in 1999, it would have grown to about $450,000 today. If the money was split evenly between the #1 and #2 ranking asset class, $100,000 would have grown to about $250,000. Equal weighting all six asset classes would have resulted in $100,000 growing to about $200,000. But if 100% of the portfolio had been invested in the #6 ranked asset class, the portfolio would still be under water at about $75,000.
Sector Rotation Strategies
From a size and style perspective, large-cap growth has been dominant for the last five years. However, there have been periods when small-cap value stocks have been strong as well.
Similarly, sectors will under- and outperform at certain times.
Looking at the last 10 years of annual sector performance using the broad Select Sector SPDR® ETFs as an indicator, technology has been the best performer three out of the past five years. Currently, it is the second-best performer with energy as the top performing sector so far in 2021. Although energy is up more than 44% through the end of November, it was the worst performing sector six out of the past seven years. On average, the difference between the best and worst performing sector in any given year is about 38%.
Five of the broad sectors—energy, technology, real estate, financials and consumer discretionary—are up more than 25% as of November 2021. 9 out of the 11 sectors are up more than 10%. Utilities and staples are the laggards.
Nasdaq Dorsey Wright conducted a study to assess the material performance from overweighting strong sectors and underweighting weak sectors. Let’s say the portfolio is always 100% invested in the top two sectors within the DALI ranks using broad sector SPDRs and it is rebalanced into the top two sectors monthly. If one invested $100,000 in the top two sectors in 1999, the portfolio would have grown to over $450,000 today. Diversifying across the top five sectors also performed well: the $100,000 portfolio would have grown to over $400,000. Investing in the S&P 500 would have grown to about $250,000. However, buying all 11 sectors in equal weights performed better than the S&P 500 over time.
DALI is designed to identify strengths across asset classes as well as within asset classes. Currently, technology is the #1 ranked sector, and consumer cyclicals/consumer discretionary ranks #2. Financials, energy and real estate round out the top 5. Industrials and basic materials are in the middle. Communication services, utilities, consumer non-cyclicals and healthcare rank at the bottom.
Nasdaq Dorsey Wright’s Sector 4 strategy uses a ranking like DALI. The strategy is to buy the top four sectors in equal weight each month if those sectors rank above cash. Currently, the top four sectors are consumer cyclicals, financials, technology and energy. Investors can gain exposure through a series of Invesco DWA Momentum Sector ETFs that buy the strongest stocks within those sectors.
The Dollar’s Influence
The U.S. dollar drives many different asset class returns over long periods of time. The currency is now in an established uptrend. Although it broke through a downtrend line in July 2021, it has continued to accelerate to the upside despite a more recent pullback in line with the equity market. Until there is topping formation, a higher dollar is probably in the cards for 2022.
Generally, a falling dollar is better for investing in international equities and commodities. A stronger dollar is better for the technology sector and the Nasdaq 100 Index®. One exception in 2021 was when the dollar broke the downtrend line in July. Using DALI, in international equities the chart moved from 243 signals down to 210 signals. In technology, the chart moved from 159 signals up to 197.
Crude oil is also bucking the trend. Although the dollar is rising, crude oil has done well due to rising demand and supply issues. That price action has pushed some commodity indexes higher. Precious metals have not done well, and they are at the bottom of the commodities ranking.
Historically, a strong dollar has provided notable headwinds for international equities. Many of the broader emerging market indexes peaked in February 2021 and steadily moved lower as the dollar strengthened. China, which is a big weight in many emerging markets indexes, has been weak. There was an initial move in Latin America early in 2021 but that faded and fell back in the international equities ranking. Developed market indexes have traded sideways after a notable run up until the beginning of 2021.
International equities are ranked #3 in DALI, so this asset class would not necessarily be overweighted in the model. That said, there are areas of opportunity in European and Asian developed markets. Opportunities can be viewed through a World ETF Matrix, which is a pre-made matrix available on Nasdaq Dorsey Wright’s Research Platform. It looks at about 50 different country ETFs, including the U.S. Currently, India, the Netherlands, Taiwan, Russia and Canada rank high in the matrix. China, Brazil, Chile, and Peru are toward the bottom of the matrix.
Fixed Income
Fixed income has bounced in the rankings in the last couple months. The 10-year treasury has been in a long-term downtrend. That said, over the last 12 months or so, there has been strength in certain sectors of the bond market, including convertible and high-yield bonds as well as TIPs. Long-term government securities, which are sensitive to interest rate movements, have done poorly.
Aggregate bonds, represented by the iShares Core U.S. Aggregate Bond ETF (AGG), have pulled back recently. The 10-year yield broke below some important support levels after seeing yields rise for much of the year. Currently, it is rallying back to an area where it might run out of gas. A 1.7% yield on the 10-year is significant because that would break past the double top formation. In the first few weeks in 2022, it would not be surprising to see the volatility in rates start to subside.
2022 will likely be another year of uncertainty and change. Investors will be laser focused on the timing of interest rate hikes, inflation and COVID-19 trends. Nasdaq Dorsey Wright will continue to leverage technical analysis and relative strength investing to develop dynamic strategies and methodologies that enable investors to achieve favorable outcomes.
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DWA provides strategies, models, or indexes for the investment product(s) discussed above and receives licensing fees from the product sponsors. Neither the information within this email, nor any opinion expressed, shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This article does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon to be successful or outperform any index, asset, or strategy. Unless otherwise stated, the returns do not include dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance, hypothetical or actual, does not guarantee future results. In all securities trading there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives.
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