Relative Rotation Graphs® and Asset Allocation

by | Dec 15, 2017 | All Articles, Technical Analysis, Education

As you have seen in other articles and blogs, Relative Rotation Graphs® (RRGs) are a great tool to determine relative strength of a basket of stocks or currencies against a benchmark, but one question we often get is “can RRGs be used for asset allocation purposes?” The answer is YES!

In this example we have created a weekly RRG with six US asset classes, using the following ETFs:

  • Equities (SPY – SPDR S&P500 ETF)
  • Government Bonds (IEF – iShares Barclays 7-10 Year Treasury Bond Fund)
  • Investment Grade Corporate Bonds (LQD – iShares iBoxx $ Investment Grade Corp Bond Fund)
  • High Yield Corporate Bonds (HYG – iShares iBoxx $ HY Corp Bond Fund)
  • Real Estate (VNQ – Vanguard REIT)
  • Commodities (DJP – iPath Bloomberg Commodity Index TR ETN)

We need to use a balanced benchmark as the comparative index, such as the Vanguard Balanced Index Fund (VBINX from Optuma’s US Funds database) which tracks the performance of a portfolio consisting of 60% US equities, and 40% US bonds (broad market-cap weighted).

Here’s a weekly RRG for the year, with the tail length set to 12 weeks:

What is noticeable straight away is that the US Equities (SPY) has remained on the right side of the chart (i.e. in a relative uptrend against the benchmark) for the entire year. In fact, it re-entered the Leading quadrant from Weakening, and continues to move further away from the benchmark with increasing momentum and strength.

By changing the colour scheme on the weekly chart to RRG Quadrant Bars and setting the benchmark for these RRG Quadrant bars to VBINX, it’s easy to see which quadrant it is in for that week. The Time Price Measure tool tells us it’s been 87 weeks since equities were lagging (red bars) or improving (blue), during which time the price has increased by over a quarter.

Commodities – as represented by the iPath Bloomberg Commodity Index Total Return ETN (DJP) – is the only other sector in the Leading quadrant, but weakness over the last few weeks (particularly in gold) has seen it head south towards Weakening. When looking at the weekly bar chart you see the break of resistance around $24 could not be maintained, and last week saw the rising trendline in place since July get breached – obviously not a positive sign!

The other asset classes in the chart (bonds and real estate) have all been in relative downtrends vis-à-vis the benchmark since October, with government bonds (IEF) being the weakest as it has moved furthest from the center of the chart. Having said that, there was an up-tick in JdK RS-Momentum this week as it finds support around $105.60, but given the fact that JdK RS-Ratio is still sloping slightly down (ie moving West on the RRG chart) and that the JdK RS-Ratio reading is the lowest in this universe continue to make it an asset class to approach with caution – just like HYG and LQD which also continue to head lower on the RS-Ratio scale.

Real Estate (VNQ) has been moving sideways all year, jumping between Lagging and Improving as seen in the bar colours, but never managing to break the strong resistance at $86. A downward break of that horizontal support level will very likely cause an acceleration down in both the price and relative graphs.

In summary, clearly equities is the asset class that needs to be overweight in a balanced portfolio until we see evidence to the contrary, such as a reversal on the RRG or a series of lower highs and lower lows.

For more information on using RRGs in Optuma see Mathew Verdouw’s webinar recording here.

Julius de Kempenaer

Julius de Kempenaer

Director, RRG Research

Julius is the creator of Relative Rotation Graphs® and the founder and director of RRG research and based in Amsterdam, the Netherlands.
He graduated from the Dutch Royal Military Academy (KMA) in 1986. In 1990 he left the air force as a captain and entered the financial industry as a portfolio manager for Equity & Law (now part of AXA investment managers).
In 1992 Julius moved to IRIS/Robeco as a buy-side quant/technical analyst until 1997 when RABObank acquired Robeco. He then moved to RABObank International as head of technical analysis on the trading floor in Utrecht. Until June 2007 he served in a similar role on the trading floor of Kempen & Co. in Amsterdam.
From 2007 to mid 2014 Julius was the director of quantitative strategy at Taler Asset Management Ltd. where he co-authored various asset allocation strategies that have been successfully implemented in discretionary managed accounts as well as a UCITS investment fund.
He left Taler in 2014 to be able to solely focus on the growth of RRG research primarily through partnerships with professional data vendors and software developers to make RRGs® available to a wider audience and provide relative strength based research to professional investors and professional entities (websites, brokers, asset managers etc) that serve retail clients.

Darren Hawkins, MSTA

Darren Hawkins, MSTA

Senior Software Specialist at Optuma

Darren is the senior Software Specialist at Optuma. He joined the company in 2009 after attending an introductory technical analysis course. Darren now instructs users all over the world, from experienced Wall Street traders and professional money managers to individual traders drawing their first trendlines.

Darren grew up in the UK and attended college in the USA where he earned a BA in Economics from St Mary's College of Maryland. He went on to spend a few years working at the Nasdaq Stock Market in Washington DC. Going on to live and work in Australia, UK and currently USA, Darren has a broad understanding of the individual needs of traders and investors utilising a wide range of methodologies.

In 2014 Darren passed the UK-based Society of Technical Analysts diploma course, and in October 2017 passed Level 2 of the CMT Program.

When not looking at charts, Darren keeps a keen eye on England's cricket team - especially if they are playing against Australia. He recently moved to Charlotte, North Carolina with wife Wendy and their labrador, Gabba.

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