Facebook (NASDAQ:FB) has significantly underperformed the S&P 500 Index since October, breaking a long trend of outperformance. IBM (NYSE:IBM) and Qualcomm (NASDAQ:QCOM) are technology stocks at different stages of showing improvement against the S&P 500 Index. In this article, I will show how these three stocks perform in comparison to the S&P 500 Index and discuss what makes a solid case for switching from one stock to another.
Facebook remains in a price uptrend but is slowing down
Facebook: Linear scale
Source: Commodity Systems Inc. (all charts)
On the linear scale, Facebook has been in a rising channel since late 2013. It has pulled back sharply since late October to the bottom of the channel. It has initially found support here but this has happened whilst the S&P 500 Index made a new high.
Semi-log scale price chart
On a semi-log scale, equal percentage changes are shown as equal distances. Shown this way, the rising trendline since May 2014 has been broken and price didn't get near the upper channel line during 2016. The rate of price appreciation has slowed.
Facebook divided by the S&P 500 Index
The performance of a stock in comparison to an index can provide insights that the price chart alone cannot. A rising stock might be dragged up by a broad market rise that has little to do with that stock, OR the rising stock may be a key factor driving the broad market advance.
By plotting a comparison between the stock and index with the stock price, we can see which of these scenarios is true.
There are two ways to graphically compare price series. We can rebase them (say to 100) at the start of the chart. This keeps two lines and we see which does better. Alternatively, we can divide one series by the other. That method is used below, where the Facebook price is divided by the S&P 500 Index. I've used the tracking ETF, the SPDR S&P 500 (NYSEARCA:SPY) to make the scale readable. Note that:
- When the line rises, Facebook is doing better than the S&P 500 Index.
- When the line falls, Facebook is doing worse than the S&P 500 Index.
- When the line tracks sideways, Facebook is performing in line with the S&P 500 Index.
- The numerical values are arbitrary but the changes show the degree of outperformance or underperformance.
Facebook price and divided by the S&P 500 Index
- When Facebook broke price resistance in July 2013, the chart of FB divided by SPY also broke resistance. We call this the price relative line or relative strength line.
- When a price resistance break is accompanied by a relative resistance break, this gives the price break extra validity. We say the price break is confirmed by the relative strength line. So this was a positive sign for FB.
- The price advance continued with new highs being confirmed by new highs in the relative strength line. Even when there wasn't simultaneous confirmation (March 2015), there was no breakdown in relative strength below a previous support level.
- The last price high in October 2016 was confirmed by relative strength.
- Following severe underperformance since October the relative support level set in July has been broken. This is the first meaningful change in the behaviour of this chart since the price uptrend began in 2013.
- The price uptrend remains in place for now, as June's price support level hasn't been broken.
Further ideas on the relative strength line
Chart analysts pay lots of attention to relative strength lines. Inferences can be draw from them, none are foolproof but the discussion on the Stockcharts.com Chart School is a good start.
The article highlights that for many portfolio managers, the relative line is more important than the price itself. OK, you already know this.
Secondly, it highlights that simple trend and divergence analysis can be applied to the relative line. Divergence in this context is where a new price high isn't accompanied by a new relative high.
In the FB chart above, the divergence stage was skipped: every new price high was matched by a new relative high. Instead, FB's relative line has moved straight to the trend change stage, by breaking support.
Thirdly, the article draws attention to the possibility of the relative line leading (turning before) the price. It says "Stocks that underperform on the way up often lead lower when the market reverses."
Here is a historical example of a break of relative support giving early warning of a price trend change.
Citigroup divided by SPDR S&P 500 : 2007
- The relative line (lower chart) broke support in June before the price broke support in July: The relative line break led the price.
- There is potentially the same order of events setting up on FB now. I'm not suggesting the scale of the decline will be similar.
How quickly does the price follow the relative?
In the above example, price quickly followed the relative line down. This was because the broad market peaked only a few months later in October 2007. If the relative line is falling and the market has peaked, the stock price must fall also.
The price can eek out more highs whilst the relative strength line falls if the broad market is still rising, as the following example shows.
IBM divided by SPDR S&P 500
- The relative line peaked in September 2011 but during a broad market uptrend, price continued slightly higher until March 2013.
- Therefore in the same way, although relative support is breaking for FB, price could hold up if the broad market holds up.
- A new relative uptrend will start if relative resistance is broken (lower chart). This might not be accompanied by a break of price resistance, especially if the broad market falls.
- There is plenty of scope for reversion for the relative line. It has fallen 53% from 1.57 in September 2011 to 0.73 now.
- When we compare Facebook with IBM, we should look for each component separately to do the right thing on their relative chart against the market index. Each side of a stock switch idea should stand on its own merits.
IBM demonstrates the following features on its relative strength line:
- Several years of underperforming SPY, demonstrated by the line falling.
- A extended period (since early 2016) of performing in line with SPY, demonstrated by sideways movement. A period of basing is often required before a trend reverses.
- The possibility (not yet achieved) of entering a new outperforming trend against SPY. This will occur on a break of resistance for the relative line.
IBM divided by FB
This chart compares IBM directly with FB. The same ideas apply as with the previous chart.
- IBM has underperformed FB since 2012 (falling line).
- IBM has performed in line with FB during 2016 (sideways range).
- The IBM divided by FB line held above January's support level in October. Since then it has broken the downtrend in place since late 2013 and tests resistance above a base formed during 2016.
- The chart is at an important juncture, with a long term trend change to IBM outperformance not far away. There is significant scope for reversion.
To complete the case for switching from FB to IBM, I'd like to see three things:
- FB divided by SPY break support - Done.
- IBM divided by SPY break resistance.
- The above chart (IBM divided by FB) break resistance.
Another stock to consider switching to is Qualcomm.
QCOM divided by SPDR S&P 500
- QCOM is ahead of IBM in its improvement in comparison to SPY.
- QCOM had a two year trend of underperforming SPY, then developed a base against SPY (performed in line with SPY) between November 2015 and July 2016.
- The break above the price base in May 2016 was not confirmed (matched) by the relative line. However, the relative downtrend had been broken and a higher relative low formed, so the picture was improving.
- In July, the price move away from the base was confirmed by the relative line breaking above its base.
- QCOM is now in an outperforming trend against SPY.
QCOM divided by FB
- QCOM underperformed FB since late 2012 (falling line).
- QCOM performed in line with FB during early 2016 (sideways range).
- QCOM broke the downtrend against FB in July 2016.
- In September the line moved clear of the base. QCOM is now in an outperforming trend against FB.
Taking the same three criteria that were applied to IBM, to complete the case for switching from FB to QCOM we required:
- FB divided by SPY breaks support - Done.
- QCOM divided by SPY breaks resistance - Done.
- The above chart (QCOM divided by FB) breaks resistance - Done.
The switch from FB to QCOM could be made now.
How much reversion could occur?
The table shows calculations applied to the IBM divided by FB and QCOM divided by FB charts. It shows:
- How much each stock underperformed Facebook between summer 2013 and the low of relative performance.
- When the low of relative performance occurred.
- How much of that decline has already been retraced.
- How much the line has already rallied from the low.
- How much further upside exists if a total retracement of 30% of the 2013 to 2016 decline is achieved.
An example calculation is below the table.
|Stock||Decline to low||Month of low||Decline retraced||Rally from low||Upside for a 30% total retracement|
- The QCOM divided by FB line declined from 2.67 to 0.40 between June 2013 and January 2016, decline of 85%.
- The line has recovered to 0.575, retracing only 8% of the decline but gaining 42% from the low.
- If 30% of the total decline is retraced, the line will reach 1.08, leaving another 88% upside from its current value of 0.575.
- If each stock were to retrace 30% of its total underperforming trend, they have significant further outperformance left.
- The data doesn't help predict anything, it shows the potential if these reversions occur.
Facebook has moved into a new trend of underperforming the S&P 500 Index. IBM and Qualcomm are at slightly different stages of their improvement against the S&P 500 Index. IBM is close to being a candidate to switch into from Facebook, whilst Qualcomm is already confirmed as candidate to switch into.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have identified stocks from the 50 most followed tickers by seekingalpha.com subscribers. This is to see how many more page views this generates (and how much more that earns me). That's today's world for you folks.