Home Info-Graphs This Looks Like A Pretty Textbook Counter-Trend Rally

This Looks Like A Pretty Textbook Counter-Trend Rally

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This Looks Like A Pretty Textbook Counter-Trend Rally by Eric Bush, CFA – Gavekal Capital

Yesterday, we noted how there has been an “anti-dollar” rally in the market recently. The stocks with the lowest correlation to the dollar (and highest correlation to the yen and euro) have been the best performers over the past month. Today, we have come across another group of stocks that have been on a nice run that we think syncs up well with our analysis from yesterday and adds an additional signal that we are most likely in the midst of a counter-trend rally.

Late cyclical stocks tend to have a negative correlation to a stronger dollar. Consequently, given what we saw yesterday in our factor analysis we are not surprised that the two best performing industry groups over the past month in the developed world have been energy (12.1%) and materials (8%).  These two industries have also been the worst performing (energy is down 27.8%) and the fourth worst performing (materials is down 14.1%) industry groups over the past year.  Whenever the worst performing stocks start to outperform in the short-term, it starts to smell like a short covering rally. So it make senses that the most shorted stocks have also strongly outperformed the market over the past 4-6 weeks. In the first chart, we show a price series of the 50 most shorted stocks in the S&P 500. These stocks have had a nice V-shaped bounce and are at the highest level they have been at since early December. In the second chart, we show the performance of these 50 stocks compared to the S&P 500. Since January 20th, the most shorted stocks are over 15% higher while the S&P 500 has risen by a little less than 8%.

counter-trend rally
Counter-Trend Rally

 

Given that we still haven’t seen a big enough expansion in 20-day new highs and that the best performing stocks over the past month or so have been those that have been beaten down the most over the previous year (and have had the most short interest), we believe we are in the midst of a counter-trend rally. At this moment, the probability of more downside in the near term is probably greater than than the probability that we have entered a new bullish phase.

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