How To Make Money In A Mixed Market

From the desk of Steve Strazza @sstrazza

First of all, thanks to everyone as always for participating in this week's Mystery Chart.

As noted in the Mystery post last week, the rounding bottom in question is a pattern we've become all too familiar with since last year.

The reason for this is simple: The chart was merely a derivative - or just another way to illustrate and visualize the overarching theme that's driving so many of our cross-asset relationships these days... The sustained rotation out of Growth  and into Value.

We've written a lot about this theme since last year, and more recently have been pounding the table on a new theme that's taken the forefront for markets across the globe... We believe we're in for a trendless or rangebound period for risk assets as well as an increasingly bifurcated or mixed market. 

Much of this divergence in performance among various groups can be directly attributed to this trend toward value and away from growth.

Not only are we seeing prices roll over for growth areas, but we're also noticing some concerning deterioration in internals for the first time in over a year. Although at the same time, value and cyclical areas of the market just registered fresh bullish initiation readings in a handful of our breadth indicators. Talk about a mixed market...

Then add the red flags we're seeing from a sentiment standpoint along with the growing number of critical stock market indexes and commodities running into logical levels of resistance, and we believe a much more cautionary approach is warranted in the near term.

So, back to the Mystery Chart now. Most of you were buyers, and so are we. You can click here to see the original chart.

It was a ratio chart of Exploration & Production stocks from the Energy sector $XOP relative to one of the hottest secular growth leaders of the past several years, Software $IGV. Price action has been muted in the sessions since so the chart looks more or less the same today with price still pressing on the upper bounds of its base.

We believe we're in the midst of a fierce reversal of fortune in favor of XOP... and in favor of all value stocks, for that matter. 

We just used this ratio as a representation of the larger trend playing out in US Equity markets right now, whereby the performance of various stocks and indexes continues to diverge significantly based on whether they fall into the growth or value category.

Here is the same chart, only this time overlaid with the Growth vs Value ratio in order to show just how tight the correlation is between the two:

Long story short, we're entering a market where there are going to be both heroes and zeros. The days of indiscriminate buying are over.

There are stocks we want to be buying, as we've been doing for a long time now... But, there are also stocks that we want to be selling, or shorting - which is something we have NOT done for a long time now. 

As JC likes to say, "that is information" and it's telling us that we're now in a market whereby investors will be rewarded for BOTH buying AND selling stocks...

With that as our backdrop, here are some pairs trades we can utilize to express this view.