Negative oil futures and a 2.5% drop in the S&P 500 ^GSPC – it’s only Tuesday and it’s already been an eventful week for markets.
But investors aren’t rudderless in this environment. To maximize your chances for upside in the sessions ahead, buy what’s working.
That might sound like simplistic advice – after all, what does an asset’s recent performance have to do with its returns going forward? Quite a lot, it turns out.
There’s considerable evidence that buying stocks with positive relative strength can generate outperformance. And that’s especially true in crisis-investing environments.
When we review similar environments over the past three decades - situations in which the S&P 500 entered a 25% or greater drawdown -- buying what’s working has dramatically boosted the odds of making money going forward.
We’re about a month past the initial 25% drawdown point in the S&P 500 right now. In the same situations during past crises, stocks had about a 50/50 chance of winding up higher another month later.
But if you build a portfolio made up of only stocks with positive six-month relative strength, the chances of winning jump to 78.4% in that same month later.
While market history never repeats, it does rhyme. And prior crisis-market data clearly show that stocks that have been working during the worst of the selloffs outperform beyond the crises.
So, what’s working here? Big tech, for starters. Large technology-sector stocks have been showing off stellar relative strength year-to-date.
Case in point: The S&P 500 is down about 13.6% year-to-date on a total-return basis, while the S&P 500 Technology Select Sector Index is down less than half that, off 5.6%.
And within big tech, a few names stand out.
An obvious one is Amazon.com (AMZN) - Get Report. The Seattle online-retail giant has been a strong performer despite the covid-19 selloff. The shares recovered from their lows quickly, just last week breaking out through their pre-crisis highs.
That’s a useful setup from a risk-management standpoint. Amazon’s breakout level right around $2,200 provides a reasonable level to park a stop, if it's violated.
Fundamentally, Alibaba sees many of the same catalysts in China that have driven Amazon higher elsewhere.
Alibaba is in a well-defined (if wide-ranging) uptrend right now, providing a set of well-defined support levels underfoot. Here again, a solid relative strength uptrend and support levels make it easy to quantify risk on this trade.
But it's not just e-commerce names that are holding up well right now.
Nvidia’s within grabbing distance of a retest of early 2020 highs right now, potentially clearing the way for a breakout in the near term.
An intermediate trendline, currently around $250, looks like a logical place to park a protective stop below. A break below that level would signal a likely double dip to long-term support right about $200.
If you’re considering boosting exposure to stocks that are working right now, take a portfolio approach and avoid cherry-picking a single name that’s working. That limits idiosyncratic risks at a time when they’re elevated.
For more trade ideas that clear the relative strength bar, keep watching this space.