XTR – The Large Cap Hypothesis

The top six of the large capitalized stocks consist of 75% of the total market capitalization. And this is one hypothesis we raised when we launched the XTR this month. Large caps still remain a very key segment for the local markets and should continue to drive relative growth in Romania stock markets.
Large cap or as we call them blue chips is a term used by the investment community to refer to companies with a market capitalization value of more than $10 billion. But considering emerging markets lack the critical mass, the capitalization categories need to be reclassified. Since the launch we also have reworked on the limits to make it more representable.
Blue chip stock globally are seen as less volatile investments as compared to owning shares in companies without blue chip status. Blue chips have an institutional status in the economy, which keeps them ahead with consistent growth and performance. Blue chip companies are also known to weather downturns and operate profitably in the face of adverse economic conditions.
We consider large cap above 2 billion Ron (~500 million Euros), Mid Cap from 0.35 billion lei till 1.99 billion lei and small cap the rest. This was the reason we added Transelectrica and Transgas to the large cap list.
The hypothesis got a positive confirmation after we crunched the data for Feb 2008. Large cap turned out to be only positive capitalization category for Feb 2008 compared to mid cap and small cap. This might look strange considering the many of the stocks have large denominations and are still not cheapest in terms of valuations.
We continue to anticipate growth and positivity from current levels.
ADVANCE DECLINE – THE BREADTH INDICATOR
Breadth indicators measure the degree to which the vast majority if issues participate in a market move. It therefore monitors the extent of the ongoing trend. Generally speaking the fewer the number of issues moving in the direction of the major averages, the greater the probability of a reversal in the ongoing trend. Breadth indicators best on the aggregate market but can be even used with sectoral indices.
The basic interpretation remains the same. The longer a price trend is maintained without a follow up by the broad market, the more vulnerable is the advance. At market bottoms, breadth is not such a useful concept for determining reversals because the majority of stocks usually coincide with or lag behind the major indices. On the few occasion when breadth reverses its downtrend before the averages, it is actually a more reliable indicator than the one at the top. This was the current case of AD indicator compared the marketwide averages on BVB.
AD issues are plotted by itself. This indicator is helpful to determine daily market strength as the readings move from overbought to oversold levels. Since the reading are sensitive and volatile, exponential moving averages are used to smooth them. AD ratio is similar to the AD issues in that it displays market breadth. The advantage of the ratio is that it remains constant regardless of the number of issues that are traded on the market (BVB in our case). AD cumulative line is used for measuring the overall marketwide strength.
So one might ask why does AD or breadth indicators work. Or for that matter why they should work in Romania. The market as a whole, discounts the business cycle and normally reaches its bull market peak 6 to 9 months before the economy reaches its peak in business activity. Since the peak in business activity is itself preceded by a deterioration of certain leading sectors such as financial, consumer spending and construction, it is logical to expect that the stocks representing these sectors will also peak ahead of the general market.
It is normal that the A/D line to coincide or lag at market bottoms. However, when the AD line refuses to confirm to a new low in the Index, the signal is unusual and very positive, but only when confirmed be a reversal in the average itself. This is the scenario in the local markets case again.
We have modeled the AD indicator for Romanian markets and the results suggested a bottom on 23 JAN. We have illustrated all the eight extreme readings and how the BET performed after that. The table below highlights the overbought percentage level. The highest reading being 100% and lowest being 0%. Higher readings suggest euphoric sentiments and lowest panic and fear. The backtested results shows that the indicator was able to identify Feb 05, Feb 06 and Jul 07 tops. And Mar 05, Jun 06 and possibly the recent Feb 08 low. As we are closing the issue prices are already 13% up from the 15 Feb low, which was identified 23 days before by the AD indicator. However, how far prices push up from here remains to be seen.
To read the latest XTR issue write to us for a free trial today or download the report from REUTERS KNOWLEDGE, YAHOO FINANCE, THOMPSON ONE or THOMPSON RESEARCH.