Unlocking the Value in Financials

The talk of the town this week has been the swift rotation out of Growth and Momentum and into the Value factor. As interest rates and yield spreads have stabilized, cyclical areas of the market such as Transports, Retail, Banks and Energy have caught a bid. While it’s likely a bullish development for the broader Equity Market to see these lagging sectors play catch up, the Growth vs Value ratio really comes down to the relationship between Technology and Financials due to the sheer size of these groups.

The S&P 500 Value ETF, $IVE has a 22% weighting in Financials while the S&P 500 Growth ETF, $IVW has only a 5% weighting in Financials versus a 26% allocation to the Tech sector. Over the trailing 10-years, Growth is up roughly 300% while Value is up only 200%, respectively, on a total return basis. But the sharp reversal in Value relative to Growth in recent weeks might be an indication that after a decade of underperformance, its finally time for Value and Financials to lead.

Here is a long-term look at the Value vs Growth ratio, which just put in a failed breakdown as prices reversed back above their record lows from 2000 and 2018.

This has the makings of a major trend reversal as prices just violated a multi-year downtrend and confirmed a long-standing momentum divergence. I wrote about this theme in more detail in the post "Is Value Back in Vogue" in July.

I marked the last two historic highs in the S&P 500 on the chart to illustrate that the Growth vs Value relationship shouldn’t be used to forecast the direction of equities as a whole. The ratio bottomed out and started rising in 2000 just as the market peaked ahead of the Dot-Com Crash but it also topped out at record highs and rolled over just ahead of the Great Financial Crisis in 2007. While this was due to the nature of each crash, as one was lead by Technology and the other by Financials – we never know what the next crisis will bring. As such, the ratio doesn’t provide much insight on the broader market, but instead tells a story of sector rotation, particularly between Tech and Financials.

Here is a ratio chart of Financials vs Technology using Sector SPDR ETF's $XLF and $XLK.

The chart has a similar look to the Value vs Growth ratio with prices in a structural downtrend and beneath key prior lows but sporting a bullish momentum divergence. If Value's outperformance is going to have legs, we should see a bear trap at these recent lows and an eventual trend reversal in this ratio like the one in Value vs Growth.

Prices recently undercut their year-to-date lows and reversed higher but remain trapped below decade-long resistance at 2009's lows. Value bulls want to see prices reclaim this key low and break back above Q2's highs ~0.37 in order to confirm a failed breakdown and counter-trend move higher.

The bottom line is that if Value stocks are finally going to outpace their Growth counterparts, this is likely happening in an environment where capital is flowing into Financials at a more aggressive pace than Technology. Some will say sector rotation like this is the lifeblood of a healthy bull market. Others will argue that seeing the strongest areas of the market such as Momentum and Growth give up their leadership is a bearish development. I'd argue that as long as former leaders continue to participate on an absolute basis, some relative rotation into lagging sectors like Financials could provide an expansion in breadth necessary to propel the market to new highs.

Hope you enjoyed this post! As always, feel free to reach out to me directly at Strazza@TheChartReport.com with any questions or comments.