Analyzing a Powerful RRG

1/?Asset Allocation

The investment process I have developed in my 30+ years in the market has three parts to it: fundamental, technical, and catalyst. Much like technical analysis, my process is fractal that means it can work at any scale. For technical analysis that means we can use the same indicators for hourly, daily, weekly or yearly. For my process, that means I can use this approach at a single security or at a portfolio level. Essentially, if a security has fundamentals, technicals, and catalysts in its favor, it is a full-sized position. If only one is in its favor it is ? of a position. If two categories cancel out, there is no position and I only watch. Much like all of technical analysis, this approach keeps a discipline that allows me to assess what at times seems to be competing flows of information.?

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The last two days, using the intermarket analysis, I covered areas that I would put into the fundamental category - growth, inflation, FOMC policy and portfolio construction. The next two days I will dig into the more technical portion of the process using more traditional technical charts.?

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The first chart today is the Relative Rotation Graph (RRG) that I first learned about when I was studying for my CMT charter. I find this graph to be immensely powerful in that it can encapsulate flows and sentiment across a number of products in one graph. A trader or investor can set it up however they want, using the products and benchmark that they wish.?

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I have used a Bloomberg NW screen that holds ETFs and Indexes across a range of products. As the benchmark, I use SOFR futures, which is a 3-month cash rate with the idea that anyone can prefer cash to these products.?

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There are four quadrants on this chart starting in the upper right and moving clockwise: leading, weakening, lagging and improving. Assets in the upper right are leading all other assets and attracting the most attention and flows. Those in the weakening category are former leaders that are starting to wane in importance. This is a critical sign of potential weakness. The next category is lagging and these are the assets that investors are leaving behind and not paying attention to. You don’t want to be here. However, every laggard eventually starts to improve and moves to the upper right. Therefore, I always find the lower left and the upper right to be the most actionable places.?

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A quick glance shows us that the crypto products like Bitcoin and Ether are the clear leaders over the past 12 weeks while oil, commodities, and China are the clear laggards. There is nothing really in the weakening category as the commodities have gone through here and into lagging. DBA - the agriculture ETF - is the only thing in the weakening category.?

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Most interesting to me are the number of products that are in the improving category. This includes; small-caps, dividend stocks, emerging markets, bonds, buywrite ETFs, and most favorite short indexes. For a market that has been criticized for not having enough breadth, there are a large number of laggards that are showing improving momentum right now.

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2/ Financial Conditions and IWM

Speaking of small-cap stocks, these had largely missed the entirety of the 2023 stock market rally until the last month of the year, when over 90% of the annual returns occurred. What drove this? We can perhaps see this in the second chart today.?

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