When stocks trade to 52-week highs, there is a temptation to chase returns. The fear of missing the rally drives traders and investors to “chase” stocks. These stocks may or may not be nearing the peak of their business cycles. It is hard to know until after the fact. Sometimes it may be best to look for cheaper stocks or bargain names that may not have rallied as much. The risk in this strategy is cheap stocks may end up as value traps.
How do you identify stocks to buy?
The top-down investment process is one way to select stocks, including bargain names.
The process includes Relative Rotation Graph (RRG) studies, SCTR analysis, Index Relative Strength analysis, and chart analysis.
Start the top-down investment process by:
(1) Identify the strongest stock markets (i.e., SPX, INDU, COMPQ, EAFE, etc.).
The Relative Rotation Graph (RRG) study of stock market indexes shows current leaderships concentrated in NDX, COMPQ, OEX, and SPX, as these markets reside within the Leading Quadrant. We will focus on the leadership markets. However, INDU and NYA are rising rapidly from the Lagging Quadrant toward the Improving Quadrant, suggesting the emergence of new leaders soon.
(2) Focus on the strongest sectors (i.e., XLK, XLI, etc.) in the strongest stock markets.
Within the 11 S&P 500 sectors, two (2) S&P 500 sectors (Technology - XLK and Consumer Discretionary - XLY) remain in the Leading Quadrant. However, both have declining relative price momentums, signaling an impending consolidation or correction. On the other hand, two (2) S&P Sectors (Financial (XLF) and Industrial (XLI)) in the Improving Quadrant show rising relative price momentums, suggesting the emergence of new leadership sectors. An SCTR study of the 11 S&P Sectors also indicates current leadership in XLK (SCTR = 98.6), XLC (92.3), XLY (94.6), and XLI (85.0).
(3) Find the best sub-industries (i.e., Software, Computer Hardware, Semiconductor, etc.) within the strongest S&P sectors.
In the Technology Sector (XLK), the strongest sub-industries ranked by SCTR are Semiconductors (97.9), Software (94.1), and Computer Hardware (93.2). Within the Consumer Discretionary Sector (XLY), the strongest sub-industries ranked by SCTR are Automobiles (SCTR = 99.9), Recreational Services (97.0), Travel & Tourism (95.1), Tires (98.9), and Home Construction (96.0).
(4) Uncover the leadership names (i.e., MSFT, AAPL, NVDA, etc.) in the best subindustry groups. NVDA, AVGO, MRVL, and ON are the current market leaders within the Technology sector/Semiconductors Subindustry.
The market strength this year may be FOMO. However, stocks may face increased volatility this week as the Fed hikes interest rates by another 25 basis points to fight inflation. The Fed may also issue hawkish guidance at the end of the FOMC meeting on Wednesday to contain investor optimism in the stock market. Three mega-cap Tech giants, including MSFT, GOOGL, and META, are due to report their second-quarter earnings this week. Cautious forward guidance can create wide swings in stock market indexes.
Will this allow for better entry points in strong markets, sectors, industries, and stocks?
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