Spotting Market Trends: What's Working Today, Why, And How to Buy It

by: Wyatt Investment Research

The "back to school' rally in stocks that started on Sept. 1 caught more than a few investors off guard. After all, following a summer of refreshingly calm market volatility few expected that stocks would jump all at once and march higher in a seemingly relentless push to reach annual highs.

But they did - and so long as you had exposure to stocks - of any market cap class - you were likely to see your portfolio rise 15% or more.

Click to enlarge

I'll pass on the easy opportunity to explain why small cap stocks, like those in the S&P 600 Small Cap Index, were the top performers over this period. If you've been a reader for long you already know why (Why do small cap stocks always outperform?).

It's more important right now to dig into which sectors of small cap stocks have been outperforming and why. Armed with this knowledge we can then seek out individual stocks in these sectors that could rise in the coming months and years.

I'll let you in on one of my tried and true methods for breaking down the market and picking out the fastest moving sectors. I can do this in less than two minutes - not accounting for the time I spend building my MS Excel based model.

I'll bet you can do it in less than 20 minutes - a pretty insignificant amount of time when you consider how powerful the knowledge can be.

My trick is based on spotting ETF trends - but not just any trends. I follow small cap sector trends in particular, and compare those to large cap sector trends.

Doing so allows me to see what sectors of the market are moving. And the comparison of small caps to large caps lets me know if the move is broad-based, or whether I need to consider other factors.

Broad based rallies are the easiest to invest in because you don't need to over-think it. Find the right sector, buy the strongest stocks in that sector, and you're off to the races. It's about as easy as it gets.

I start with the PowerShares Small Cap Sector ETFs, which launched in April of this year. Then compare their returns to Select Sector SPDRs ETFs. Both companies have nine ETFs that are designed to track the nine sectors of the S&P indices.

Since the back-to-school stock market rally kicked off on Sept. 1 small cap energy stocks have handily outperformed, rising 46.3%. They have beaten large-cap energy stocks by 21.8%. Keep in mind I'm comparing ETFs here - so there is some noise in these returns from trading volume, expense ratios, etc. But for my purposes of trend spotting I'm not remotely concerned about small impacts like these.

This trend is telling me to buy energy stocks, and I recommend you do the same. Why? Because this is what's working right now. Remember, don't make it too difficult when trend-spotting - there's plenty of room for that when checking out the fundamentals of particular stocks.

Second on my list are technology stocks. Small cap stocks in this sector have outperformed by rising 30.9% since Sept. 1, besting large cap technology stocks by 12.2%. You should buy solid small cap technology stocks now.

Third on our list are materials small caps - they've risen 27.9% and have outperformed large-cap tech by 10.9%.

Here's the entire table of sector ETF returns, and relative outperformance of small cap stocks, as measured by these particular groups of ETFs, since Sept. 1.

You can calculate all of these returns yourself, whenever you want and over whatever time period you like, by looking in the "historical prices" section on Yahoo Finance. Click here to get the returns for XLES, and then just input whatever ticker symbol you like in the call box on the upper right side of the screen. You can set the date range, and then scroll through the prices to find the date you want.

This simple trick will help you spot trends, and if you use if on a regular basis as I do, you'll be able to jump into the market with greater confidence that you are buying into the right sector.

There is one caveat you need to be aware of, however: All trends end. Nothing lasts forever, so don't expect that past performance is predictive of future results - it's not. But most trends tend to last for a while, and using this method you can spot them early, and help you invest accordingly.

About this article:

Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here