Using Rotation Graphs to Find a German Opportunity
Featuring Trevor Neil
Published on: May 8th, 2019 • Duration: 14 minutesTrevor Neil of Beta Group discusses how he uses relative rotation graphs to aid in a top-down approach to stock picking. He unpacks his process of starting with global indices, drills down on the sectors, and suggests specific stocks to make the play. He reveals his current trade idea on Nemetschek, a stock on the German DAX, in this interview with Roger Hirst. Filmed on May 3, 2019 in London.
ROGER HIRST: Welcome to Real Vision's Trade Ideas. Today, we have Trevor Neil of Beta Group. Welcome, Trevor.
TREVOR NEIL: It's a great pleasure to be here.
ROGER HIRST: Thank you very much for coming. And I believe today is your first visit to Real Vision.
TREVOR NEIL: Yes, it is. I'm excited.
ROGER HIRST: Brilliant. Good. Well, could you give me a little bit about yourself just for the viewers so they can know a bit about your background?
TREVOR NEIL: Yes. Well, I've been in the industry- I started as a trader 40 years ago, I'm ashamed to say. My first job was with Merrill Lynch as a coffee trader on the coffee exchange, and I moved to other soft commodities and as a broker. And then I moved towards fund management and other financial instruments, derivatives and then I worked for a bank running large fund for them, systematically traded, technically driven fund. Then I left the bank, had another smell on the floor trading bunds.
And I then worked for three years as head of technical analysis of Bloomberg, which I enjoyed a lot. Then I ran another hedge fund based in South Africa. And then 2006, I sold out in that and moved back to the UK, run a small fund, and also a consultant technical analysis.
ROGER HIRST: Excellent. And you've got an idea today which is based around technical analysis. Could you outline the basics of your idea?
TREVOR NEIL: Yes. Well, what we're going to do is we're going to have a very much a top-down approach. We're going to look at the world first of all. And we're going to look at how the major stock indices are relating to each other. Then we're going to go down to one which I think is offering potential recovery, potential catch up potential. Then we're going to break that down to what area should we be looking at. And then in the end, come up with an individual stock. So, we're going to start from looking from outer space and end up with a security.
ROGER HIRST: And we end up somewhere in Europe on this one, though?
TREVOR NEIL: Yes, indeed.
ROGER HIRST: Excellent. Okay. Well, if you could maybe outline that global perspective, the big picture view that you have.
TREVOR NEIL: Now, this first chart is a type that you may not have seen before. These are very popular in the institutional world. They're on Bloomberg. They're on Icon, the definitive platform, but also available on stockcharts.com and some specialist charting packages. They're called relative rotation graphs. And what they allow people to do is to look at many securities in one picture. Normally, you would need many graphs to compare one thing versus another versus another versus another. But here, we've got them all normalized together so we can compare one with another.
This first one is showing major stock indices in the world. In the middle, in the crosshair of it is the MSCI world index. So, this is how everything is relating to the world, if you like. We've got four quadrants, the top right-hand quadrant is- to be in that quadrant, you have to be overperforming the benchmark, which is in this case is the MSCI world. And then being in the top half of the screen, so this top right-hand quadrant means with positive momentum. This is the interesting thing about the graph. It's not just the relative strength, but it's also whether the relative strength is increasing or decreasing. So, strong things getting stronger are up there on the top right.
Bottom right is strong things that are weakening, maybe things you'd be lightening in your portfolio. And then bottom left is the place you definitely don't want to be. That's poorly performing things that have gotten no positive momentum. That's the awful things. And then maybe depending on your attitude to risk, the interesting area is top left. These are underperforming things but are coming up strongly in the list, the list itself is dynamic, you've got the top thing. Many people would just want to be in the best things. But actually, the outperformance is made by joining in the things as they move up through the list. And that's where you're going to find them.
ROGER HIRST: Is that where you're looking?
TREVOR NEIL: Yes, it is. And you can see the thing which is most to the right and highest on the screen. So, that means the strongest index with the greatest positive momentum, relative momentum is the Shanghai Composite Index. And this is extremely strong at the moment, having been weak, but this is now a big bounce. So, the price of the index has improved very sharply indeed, taking it away from the crowd completely. And so, there's a lot of outperformance being generated there. The relative rotation graph also shows you is that really you should have bought that earlier. It's arrived. ROGER HIRST: So, you missed it basically, yeah. TREVOR NEIL: You've missed it. The tails on the graph show where it was last week, the week before, the week before so you can see how it's progressed. So, really, the interesting thing and where I want to draw your attention is, is not the things which have already got there. But the things which look like they're going to get there. Now, things that are close to the center of the- close to the index are things which are correlating with the index. And therefore, if you buy them there, they're really just matching the index. So, you're not getting a genuine alpha from those things.
But you'll see that in the top left-hand quadrant in that interesting quadrant, from my point of view, moving at an angle and moving northeast- northeast means that it's increasing in relative performance, but also with positive momentum is the DAX. It is close to the center that would- it's not ideal further away would be better. But it's an early case for this. And many of you will be- where we're looking at the graph of the DAX itself. The DAX was particularly weak amongst the European group. We had a head and shoulders pattern there, which has now been fully resolved, and we've met the objective almost exactly, and now we're bouncing strongly from it.
So, compared to the CAC and the other European indices, this one has got catch up, and it seems to be catching up, and also speeding up as it catches up. So, it wants to bounce hard. So, I think we're going to get outperformance from Germany, within the European sector and Europe itself is now looking much better than it was.
ROGER HIRST: And within the DAX presumably, it sounds like you're not going to plan for the DAX itself yet, you're going to dig down even deeper for something which within the DAX, is showing a similar relative performance?
TREVOR NEIL: Yes. And we could buy the DAX but actually, can we do better? Can we break this up a bit? So, the DAX is made up as all indices are of different sectors. We've got a construction sector, which is in fact the strongest sector. And then we've got software and utilities and technology and financials like as we have everywhere else. So, where should we head in this?
So, once again, as we look at this relative rotation graph, we see that amongst the DAX now, we have the DAX in the middle as the benchmark and then we have the constituents around it. The strongest is the construction sector. And this is led by- as a very dominant equity, larger equity it appear. But again, that's something you should have bought earlier. It's already arrived, if you like.
So, we're looking again, and more aggressive to- and we're moving into this sector, which I think looks good because of the direction which is moving, getting stronger and increasing speed as it gets stronger. And this is the software sector. So, within the DAX, we're honing in on the software sector.
ROGER HIRST: And are there number of stocks there? Because most people think of German software as being SAP is more through the map.
TREVOR NEIL: Yes, actually, there's quite a lot of stocks in there. The SAP of course, is dominant, but if you want to get real outperformance, it's not from the thing which is driving the benchmark and correlating with the benchmark. We need the smaller ones to get the alpha and the one I have chosen is Nemetschek. Nemetschek, as you can see from the position of it, is moving nicely in the direction we like. It's already moved up quite a lot away from the middle. So, we are getting genuine outperformance in it but also with positive momentum.
So, having started talking about the view of the world from above, and drilling down to the opportunity, I think from the DAX itself, and then within the DAX down into the software sector of it, and then choosing one stock from the software, which I think will outperform the rest of the stocks in the sector.
ROGER HIRST: So, in terms of the timeframe- is the timeframe based on the distance we've traveled up already? Or is based on that chart you're talking about before, the quadrant chart?
TREVOR NEIL: Yes. In the terms of the timeframe, this type of analysis is definitely intermediate term. So, we're not talking about things like this happening in days at all. Also not talking about it happening in years. It would measure in weeks and months. I would look for the move itself to be the length of the AB, the CD leg. And the CD leg is very often either the same time- length of time as the AB leg or excuse my using Fibonacci 1.618 time set that, so longer in other words. So, this last leg is often longer. So, how many months would this be? Well, this would be a view for about six months.
ROGER HIRST: And there's always- anything long equities. There's always a lot of skeptics about the equity market where we are. So, let's say somebody wants to be like the idea and there's a relative performance trade, so they want to belong the stock, how would they pick a short? Will they pick it from one of the quadrants you talked about? And how would they go with that?
TREVOR NEIL: Yeah. I would use the relative rotation graphs again, because what- the risk you're talking about there is a relative risk. Something against something. And just answering the question more generally, rather than answering for this individual stock, the strong things are the things that are in the top right-hand quadrant and moving northeast.
The weakest things and these would be the things- the best thing to use as hedges are things which are in the bottom left-hand quadrant, the weak quadrant. And these are things which are underperforming on a relative basis and have got no upside momentum at all in them. And so, even ideally, if you find things which were going Southwest. So, anything that's in that quadrant is your best hedge rather than just using an index and why not be long with the strongest and short with the weakest?
ROGER HIRST: Okay, so the all-important with the trade idea is what's your entry point? What's your price target? And do you have a stop level? Where would that be?
TREVOR NEIL: Yes. What we can see is that currently, it's just broken to the previous high. It broke through then pulled back and this is a very typical behavior when new highs are made. And this is a healthy condition for the market. So, now, the stops have gone and have been absorbed, retest and now, it should now continue forward from here. So, I would like to buy here on this break to new highs, which I think is a good-looking break out.
But the stop loss question depends on you and your attitude to risk. But there's an obvious technical point which is below the long bar here. So, cast it around $130. So, you see that long bar. And then if we look at in the context of this move, we started to move I think it's likely to extend. It could be as long as the move up the way you've had, and this would take us beyond $200, perhaps $220 as an objective for this move. If we're just saying that we're going to make an equal move compared to the first move.
So, if we think of it like AB, and then we've pulled back, now, we've gone up, now, we're approaching and breaking B and so the CD leg should be as long as the AB and this will take us actually to $220.
ROGER HIRST: Sounds very good. Sounds fair enough. So, in summary, basically, we're looking at is Nemetschek stock. You're looking at- this is basically a relative trade, more relative trade based. It's a trade where this is a relative underperformer where the strength we've already been seen in Shanghai Composite. It's now coming through in the DAX and within the DAX, Nemetschek looks like a great stock. Your entry point is the $150 level, which has been the breakout level with a target over maybe six months plus but certainly not longer, longer-term of $200 to $220, with a stop around about $130. And if you wanted to put it as a long, short trade, you pick something from the bottom left quadrant.
TREVOR NEIL: Quadrant, yes.
ROGER HIRST: Excellent.
TREVOR NEIL: Thank you very much.
ROGER HIRST: Thank you very, very much indeed. Trevor's idea is to buy Nemetschek, which is a tech stock in Germany. Entry point is around about the $150 level, the targets over six months is $200 to $220. And the stop loss level would be around about the $130 level. That was Trevor Neil talking about his Nemetschek idea. And remember, these are trade ideas and not investment advice, do your own research, work out your own risk limits, and obviously trade and invest accordingly. Thank you very much.