2023-12-24 06:34:19 ET
Summary
- Equities have been on an eight-week winning streak, but it may be coming to an end soon.
- Large cap growth stocks, like those in the Schwab U.S. Large-Cap Growth ETF (SCHG), have been leading the way.
- SCHG is well-constructed and has outperformed benchmarks, but caution is advised due to short-term headwinds and overbought conditions.
Equities have continued their relentless march higher, posting eight consecutive weeks of gains since this rally began. That’s an incredible streak, and it shows that bulls are well and truly in charge. However, winning streaks don’t last forever and in my view, this one is quite long in the tooth.
Large cap growth stocks have led the way for US equities in 2023, and I believe that is set to continue into next year. For that reason, I continue to think exposure to large cap growth is a favorable strategy medium term. One way to do that is with a fantastic ETF run by Schwab, the Schwab U.S. Large-Cap Growth ETF ( SCHG ).
This fund is extremely well constructed and has many favorable characteristics for a stock fund. It has vastly outperformed just about every benchmark I can think of in 2023, and as I said earlier, I believe that will continue into 2024. There is, however, a big caveat shorter-term, which we’ll dig into below. Despite this caveat, I’m placing a buy rating on SCHG.
What is SCHG?
Put simply, SCHG is a large cap growth stock fund that is designed to track the Dow Jones U.S. Large-Cap Growth Total Stock Market Index. In pursuit of this, SCHG is designed to be low-cost and tax-efficient, owning only large cap stocks that have meaningful growth potential. Now, this obviously means value-oriented investors will likely find the holdings to be unfavorable given pretty much nothing in this fund would be considered cheap in the traditional sense of a low P/E ratio. However, we’re in the middle of a raging bull market, and you don’t want cheap stocks; you want stocks that will outperform, and that’s what SCHG owns.
To be clear, there will be a time and a place when SCHG will be positioned incorrectly, but that time is not now. Let’s look at the holdings.
Portfolio turnover is diminutive at less than 5%, meaning the fund is quite tax-efficient. This is a true buy-and-hold fund, which is great for those investors that want a maintenance-free fund to own. The fund holds ~250 stocks, which is a huge list. However, as we can see below, the diversification offered by these holdings is nowhere near what you might expect.
The top 10 stocks comprise ~55% of total holdings, meaning the other 241 stocks only make up the balance of ~45%. This is why it’s important to understand exactly what any fund that you buy actually owns, because if you’re looking for heavy diversification, this fund is not for you. As I said above, however, I think these are exactly the kinds of stocks that will continue to outperform in 2024. If you disagree with that, SCHG is not for you.
Valuations are stretched in this space, as you’d probably imagine given these are growth-oriented stocks. The average forward P/E is nearly 33 , so again, these are not value stocks. In addition, the weighted average market cap – driven by those large positions in mega-cap tech we looked at above – is about $1.2 trillion.
Tech unsurprisingly dominates the holdings list at ~47%. Behind that is consumer cyclical and communication, both of which are growth-oriented sectors that are sensitive to economic strength. The first defensive sector is health care at 12%, but the top 72% is in higher-risk, higher-reward sectors of the market. I’m good with that given we’re in a bull market, but SCHG is likely to get pummeled the next time we have a bear market.
SCHG is overall an extremely well-constructed fund that is very cheap to own, and that I believe is positioned for outperformance once again in 2024. However, there are significant short-term headwinds in the price chart I believe are worth noting, and I’ll explain those now.
Short-term caution, medium-term giddy up
Let’s start with a 2023 chart of SCHG to illustrate a couple of different important points. And before we begin, just recall from above that I think SCHG is going much higher than it is now in 2024. The below is simply a short-term cautious view before what I believe will be new highs.
First, I’ve drawn in the bearish channel that persisted for about three months earlier this year. Second, the breakout point that took place in November, which closely corresponded with the 20-day exponential moving average bullishly crossing the 50-day simple moving average. And third, the negative divergence that has formed on the PPO.
The channel is a thing of the past, as the breakout never even tested the breakout point; SCHG just exploded higher. However, the start of the bearish channel at $78 now corresponds to a double bottom put in during November and December, so that’s an extremely important support level that I believe will hold on any tests. That’s the line in the sand for the bulls to defend, if we get there.
The negative divergence is the difference between the PPO, which has put in a lower high since November, and the price chart, which has put in a higher high. This divergence is generally a warning sign of upside exhaustion (the opposite works for finding the end to downtrends). Negative divergences are not guarantees, but they’re fairly reliable in terms of being a warning sign.
Now, given we have a negative divergence in momentum, I think the below evidence suggests even further caution given we have a handful of red flags from a short-term perspective. This is a two-year chart of SCHG with some different indicators thrown in that in my view, corroborate the idea that we need a pullback to reset momentum.
I’ve added the percentage of S&P 500 stocks that are above their respective 200-day moving averages, as well as the S&P 500 bullish percent index. The latter is a metric that uses point-and-figure charts to determine if stocks are behaving bullishly or bearishly, and you can read more about it here if you’re curious.
I’ve drawn in two vertical blue lines for the past two instances of the 200-day MA metric being ~75 and the BPI being near 80, both of which are directly comparable to today’s conditions. The February 2023 instance resulted in a ~9% decline, while the July instance resulted in about the same, depending upon where you measure the bottom. I’m not suggesting we have to see a 9% decline in SCHG, but I am suggesting it’s possible to see a pretty meaningful selling episode here.
In my view, SCHG and indeed pretty much everything else is extremely overbought and sentiment is far too bullish. I would really like to see SCHG test the support level of $78 to reset momentum, and then we should be good for moving to new highs.
If we wrap all of this up, I see SCHG as an excellent way to take advantage of what I believe are very bullish conditions for equities into 2024. The issue is that SCHG – like just about everything else – is way overbought and in desperate need of some selling. Sentiment is far too bullish so while I’m putting a buy on SCHG, it comes with the caveat that I would be much happier with the price closer to that critical $78 level, given I see very high risks short-term.
For further details see:
SCHG: Owning The Best For 2024, But There's A Catch