From the desk of Steve Strazza @sstrazza and Louis Sykes @haumicharts
The same strong rotational currents that have been in place in the US since last summer have finally begun to spill over to International stocks… but, not all of them.
For the first time in about a decade, evidence suggests that stock markets around the world have finally built a strong foundation relative to their US counterparts, and might just be ready for a sustained period of outperformance.
How big the move will be and how long it will last are always some of the most difficult variables to predict. We can merely position ourselves accordingly based on the information we do have, and then be keenly aware of new data points as they come in, and constantly re-evaluate and adjust our outlook as appropriate.
As for the potential structural bull-to-bear reversal in the long-running trend of outperformance from US stocks… the seeds have definitely been planted for such a development to occur.
Now, we can only sit back and wait to see if those seeds blossom into something real or if they’re duds – in which case the recent price action in favor of International stocks will likely unwind and end up being just another dead-cat bounce.
In this post, we’ll run through some of the things we’re currently keeping a close eye on for an early indication as to whether these recent changes in the global landscape are likely to have some real staying power this time around.
From a weight of the evidence standpoint, we continue to see more and more derivatives of the tech vs financials theme resolve in the direction of financials.
This continues to bolster our view that the rotation into value and cyclicals is much more than just a tactical development. Instead, we continue to lean further toward the view that we’re in the early innings of new secular trends that will result in years of outperformance from value-oriented areas of the market, all else equal.
More or less ALL of the relative trend reversals we’re currently seeing play out in any material way are being driven in large part by the relative exposure that these various groups have to value stocks.
This includes cross-asset relationships such as small-caps over large-caps… and of course, international stocks over US ones, which we’ll discuss in more detail now.
We’re probably seeing the most mixed signals out of the US vs Ex-US trend than any of the others right now. Like any good technician, we always play devil’s advocate, and identify the charts and potential developments that could prove our thesis wrong.
Let’s kick this analysis off with this week’s Mystery Chart! Thanks to all of those who participated and provided feedback as always.
It was a ratio chart of the All-World ex-US Small-Cap ETF $VSS relative to their US Small-Cap counterparts in the Russell 2000 $IWM.
A lot of you wanted to be patient with this chart and wait for more data to either confirm the continuance of this downtrend or provide more concrete evidence that some mean reversion is indeed underway. We’d agree.
In our view, there’s simply not enough here to indicate that this trend is ready to bottom out and reverse higher like so many others have recently.
So why do we even care about this chart?
This is one of those “mixed signals” we were just alluding to as the price action from this ratio flies right in the face of our view that a trend reversal in favor of international stocks is underway. This ratio shows nothing but continued outperformance from the US… albeit on a Small-Cap basis.
So, what if we look at the same relationship but compare large and mega-cap stocks instead? The picture is much different…
As opposed to collapsing lower like their Small-Cap peers are, International Large-Caps have been outperforming the S&P 500 since about Labor Day of last year and are currently pressing against the upper boundary of a decade-long downtrend line. This trend most certainly looks vulnerable, especially with the potential momentum divergence.
How about if we take a closer look. Here’s the same ratio, but zoomed-in on a daily chart.
The ratio appeared to be resolving higher and completing its basing pattern with a bullish breakout in January, but prices have since retreated right back beneath the breakout level.
Was this just a failed breakout earlier in the year, and this ratio now follows the path of Small-Caps lower?
Or, were January’s highs merely a false start and we’re currently looking at a bear trap that soon rips higher and confirms this bullish rounding bottom formation?
Only time will tell, but just like 1.65-1.70 is the line in the sand for growth vs value, the make or break level for International vs Us is right here at the current price of 0.16.
If we’re above there, we want to bet on sustained outperformance from stocks outside of the US. In this environment, we’re likely to see this small-cap ratio finally reverse higher as well. That’s definitely something we’ll be watching for confirmation.
On the other hand, if we’re below 0.16 we can only make the bet that the current consolidation is either resolving lower or simply requires more basing time to build up the energy needed to eventually break higher. In either case, we’re either losing money or paying opportunity cost, so we want to stay away from this trend until we have a clearer signal.
Let’s look at both ratios together now in order to better visualize the recent divergence in these large and small-cap relative trends.
As you can see, the small-cap ratio has accelerated to the downside since last September, while the large-cap ratio has done the exact opposite, and has been trending higher.
BUT! We’re finally starting to see evidence of this divergence clearing itself up as VEU/SPY has retreated over the past two months, catching-down to the small-cap ratio in a way.
This definitely warrants a more cautionary approach towards this relative theme for now. Until we see both start trending together in concert, the jury remains out and we simply want to remain on the sidelines as spectators until we have more concrete data to act upon.
Since these ratios are giving us such an ambiguous message right now, we’re looking to the other derivative ratios of growth/tech vs value/financials for additional insight.
Based on that evidence, the most prudent position is a neutral bias as it relates to this particular trend of International vs US, for now. At the end of the day, we can use as much intermarket analysis as we’d like, but we still need to judge each asset and trend on its own merit.
With that said, we still need to factor in the overwhelming evidence that suggests this value over growth rotation is here to stay… And if we’re in an environment where this trend is continuing to play out, it’s hard to imagine that International stocks won’t be outperforming their US peers.
So, while we don’t want to bet on it happening just yet, we can anticipate it and be ready if and when it does happen.
If this scenario that we’re anticipating is to play out, we could very well see the VSS/IWM ratio make a move like this in the near future…
Could this failed breakdown and confirmed bullish momentum divergence give international small-caps the juice needed to finally spark a major relative reversal that results in some sustained outperformance from this group of stocks.
We’ll know soon.
To recap, International markets are still looking promising across the board, as most regions continue to benefit from the strong performance out of value and cyclical groups.
While we’ve raised a concerning data point in this post… we need to remember it’s still just one piece of data within a sea of other information. It’s definitely something to keep an eye on, and we are, but it’s also important to put it into its proper context. And when we do, we’re reminded that the rest of the complementary evidence still far outweighs what we’re seeing from this single ratio chart.
Long story short, it’s always good practice to be familiar with the other sides’ arguments and talking points. Be skeptical. Question your views. Try and poke holes in your thesis. All that stuff is great. And if what you find doesn’t reinforce your position, then you should probably re-evaluate that position.
But at the same time, don’t overcomplicate your analysis. That NEVER helps. If the answer is clear and simple. Embrace it. It won’t always be that way, trust me.
Considering the overwhelming evidence favoring our current position, we’re following our own advice and keeping it simple for now. We expect this whole rotation to deepen in the coming months, in which case international small-caps are likely to become a future leadership group and yet another avenue to express our bullish macro thesis.
Thanks for reading and please let us know if you have any questions!