Why We Like Growth Over Value Moving Forward

JC Parets
July 11, 2016

Since the Summer of of last year, the relationship between growth stocks and value stocks has been ironing out what traditionally might be considered a major topping pattern. This would suggest that value stocks should outperform growth moving forward. Last month, however, this ratio confirmed what looks to me like a failed breakdown and bullish momentum divergence. In my experience, this is an ideal recipe for a squeeze higher in the spread.

Here is a chart of the Russell 1000 Growth Index fund vs the Russell 1000 Value Index fund. The key support levels, or "neckline", if you will, comes in just below 0.98 where we also find the 38.2% retracement of the entire 2014-2015 rally in Growth over Value:

iwfiwd

Notice how when the ratio broke "the neckline" of what many would consider a "head & shoulders" pattern, momentum put in a bullish divergence by putting in a higher low, and then the ratio quickly got back above that key support. This is pretty standard behavior as head & shoulders patterns might be popular because it has a silly name, but are actually extremely rare. That's because markets trend by nature, and a head & shoulders pattern is a type of reversal. We therefore want to be long of Growth here and short Value to take advantage of the coming expansion in this spread (IWF/IWD).

Price target-wise, I think the catalyst for a major move higher is here. We have the right ingredients to take growth to fresh highs vs value. The 161.8% extension of the correction since last year would take us up above 107:

iwfiwd d

As long as this ratio is above the lows from October and April, we want to be long Growth stocks and short Value. I think this one has legs.

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