In 2017, we saw an acceleration of the decade-long trend of growth outperforming value, and after further deterioration in this ratio to start the year, the weight of the evidence is suggesting that a bottom may be in.
Below is a weekly chart of the Russell 2000 value exchange-traded fund (ETF) relative to its growth counterpart. This ratio has been in a clear downtrend since its several failed breakout attempts in 2004, 2005 and 2006, but after hitting 17-year lows just a few weeks ago, some signs of selling exhaustion have emerged. (See also: Value or Growth Stocks: Which Are Better?)
Earlier this year, prices tested the 2015 lows and bounced slightly, but more recently, prices undercut support and made new lows, only to quickly reverse higher. By closing back above the 2015 low, prices confirmed the potential bullish momentum divergence and failed breakdown that had developed. Generally, failed moves lead to fast moves in the opposite direction, which would suggest that we want to be aggressively long value relative to growth as long as this ratio remains above its March lows. With a price target at former support and resistance near the late 2016 highs, we’ve got nearly 18% upside and only 2% downside from current levels.
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The Bottom Line
Counter-trend moves are more difficult to trade, but failed breakdowns paired with momentum divergences tend to be very powerful signals, regardless of the directional outcome. If we’re correct, this ratio should move higher quickly to confirm our thesis that value is set to outperform growth over the intermediate term. If we’re wrong and prices make new lows, it will indicate that selling pressure is very strong and that this downtrend has further to go, likely back toward the lows set in 2000.
Whether you’re trading the ratio outright or using this relationship for context about the broader market, it’s clear that the reward/risk is ridiculously skewed in the favor of the bulls at current levels.
Thanks for reading, and please contact the All Star Charts Team if you have any questions.