ETFOptimize Insights

Data-driven Analysis of the Critical Market Indicators
that Determine Strategy Timing and Selection

ETFOptimize Insights

Uncertainty Ahead...


Note: This content is for informational purposes only and should NOT be used as the basis for investment decisions or discretionary overrides of the ETFOptimize Premium Strategy recommendations. Subscribers should follow the recommendations of their quantitative models to the the letter, without fail. Any divergence from the strategy recommendations will effectively introduce errors of human judgement, which eliminates all the benefits and outperformance investors receive from a systematic investment approach.



Several Critical Indicators Issue a Warning

This week, a number of our key indicators have signaled that a 'Risk-Off' positioning is appropriate at this time. Keep in mind that we use composites of many indicators, in different configurations, for each of our models. Unlike other advisories, we don't rely on one or two indicators to determine whether it's appropriate to avoid market exposure at any given time. We use composites of more indicators than any other firm of which we are aware.

We recently updated our indicators and now use more than 50 different data sets (up from 38 previously) to determine the proper market exposure and ETF selection for various models. Each model has a different level of risk that investors can determine is appropriate for their needs. The indicators shown in this article (below) are a sampling of a few of our many indicators.

An indicator leading the way with a noticeable move toward caution is our 'Momentum of Fear' Indicator ($MOFI), which we introduced in our October 11 ETFOptimize Insights article.

Chart 1 below shows the 'Momentum of Fear' Indicator (lower window) moving above its signal line about two weeks ago, with this indicator now recommending 'Risk Off.' The red-shaded areas show where the indicator rose above its signal line, indicating increased risk. We can review these periods of increased risk to see how they correlated with the S&P 500 declines in the top window, which shows an excellent correlation.

Based on the CBOE Volatility Index ($VIX), the $MOFI tracks trader's hedges against the downside volatility of the S&P 500 Index ETF (SPY). Traders buy hedges—'puts' on the S&P 500—when they perceive that risk is increasing, which provides us with a direct, market-based measure of investor's perceptions.

With $VIX often referred to as the 'Fear Index,' our $MOFI measure assesses the rate of momentum with which $VIX is changing directions—in other words, the intensity of investor fear—a far more revealing measure than the absolute level of the $VIX index, which is what is used as an indicator of investor fear by most analysts.


Chart 1: The ETFOptimize Momentum of Fear Indicator ($MOFI) surged sharply above its signal line in mid-October, signifying increased risk.


We find that the momentum—i.e., the intensity—of an indicator's direction changes are a far more accurate signal of increased risk than an indicator's absolute level at any given time.

Chart 2 below shows a different view of the Momentum of Fear Indicator ($MOFI) of the S&P 500 in the top window, the raw indicator readings in the middle pane, and the indicator signals in the bottom window.


Chart 2: The ETFOptimize Momentum of Fear Indicator surged sharply above zero in mid-October, signifying sharply increased risk.


Chart 2 above shows that our Momentum of Fear Indicator is currently showing a significant level of risk (a reading of zero), suggesting that the level of investor fear has accelerated sharply higher in advance of the Nov. 3 election. Investors are taking precautionary measures—as they did earlier this year when the COVID-19 Pandemic became a threat (and well before the market decline), in advance of the election this week.

Our portfolios have also taken precautionary measures, not by purchasing puts on the S&P 500, but by moving in cash-equivalent positions.


Progressive Blend Earnings Composite (SP500 PBEC)

Our S&P 500 Progressive Blend Earnings Composite (SP500 PBEC) combines S&P 500 As-Reported Earnings (TTM), the Current Year's earning's estimate (CY), and Next Year's Earnings estimate (NY) in an algorithm that increasingly weights actual earnings as each quarter of the year progresses.

Chart 3 below shows that our S&P 500 PBEC Indicator ($MT09) is currently reading zero, which shows a Risk-Off signal. This signal indicates that since the March crash that coincided with COVID hitting the US, there has not been a recovery of S&P 500 earnings—or earnings estimates—of enough significance to be meaningfully bullish. This indicator is also recommending Risk Off.


Chart 3: Our S&P 500 Progressive Blend Earnings Composite (PBEC) dropped below its signal line in March, and earnings have yet to recover for a positive signal.


Percentage of S&P 500 Shares Above Their 200-Day Moving Average

One of our favorite Breadth Indicators because of its accuracy is the Percentage of S&P 500 shares above their 200-day Moving Average, which is indicator $BI01 in our 50+ indicator lineup.

Chart 4 below shows the raw number of S&P 500 stocks that are above their 200-day moving average at any given time since January 1999. Currently, that figure stands at 59.64%, which is a bearish reading (below 70). You can see from the chart below that the percentage of S&P 500 stocks above their 200-day moving average dropped to near-zero with the March selloff, but bottomed with a 'V'-shape and has been rapidly rising since—until last week. It reached a level of 70 last week but dropped below 60 this week.


Chart 4: The percentage of S&P 500 stocks above their 200-day moving average is an excellent leading indicator of market strength and risk.


A quick perusal of Chart 4 above reveals that this series is very volatile and would present many whipsaws in its signals. We can slow those signals down and filter out the weakest moves by using a 10-day moving average of the indicator. If you look closely and compare the two charts, you'll see that this EMA results in smoother signals and fewer whipsaws, as displayed in Chart 5 below:



Chart 5: Applying a 10-day moving average smooths out some of the less-important, relatively small whipsaws, and makes the indicator more usable.


We can then produce a binary, One/Zero, Risk-On/Risk-Off indicator, as show by the $BI01 Signals (200s_10 version) displayed in Chart 6 below, which (while difficult to see) just switched to a reading of Zero (Risk-Off):



Chart 6: The signals attained from the BREADTH data series (% Above 200-day SMA, Chart 5) provides an accurate leading indicator of S&P 500 risk.


And finally, Chart 7 below shows a closer view of the 10-day EMA of the Percentage of S&P 500 Shares above their 200-day SMA ($BI01) for the last two years. In this closer view, we can see that the indicator accurately signaled the late-2018 decline (far left), some S&P 500 weakness in mid-2019, and appropriately signaled to exit before the March-2020 Covid-Pandemic Selloff earlier this year caused a significant loss. The S&P 500 had declined only 5% before this indicator signaled to exit risk exposure.


Chart 7: This closer view of the % of "S&P 500 Shares Above their 200-day SMA" shows the signals for the last two years. The signal is currently 0.


Perhaps significantly, Chart 7 above shows the indicator has once again dropped to Zero this week—potentially a leading indicator of further weakness ahead for the S&P 500 and its constituents—if this indicator continues to be the accurate leading indicator it has shown itself to be in the past.

Worthwhile to note, we also apply this same indicator and our other Breadth Indicators (New Highs/New Lows, Advancing vs. Declining Shares, High Beta vs. Low Beta, Bullish Percent Index, etc.) to the NASDAQ 100, Russell 2000, and several other indices, depending on the ETFOptimize model for which the indicator is used.



Depending on whether Tuesday's election is an overwhelming landslide—or a contested result that could tear this country apart—will likely determine how rapidly our models return to the market. If the outcome is unequivocally clear by Wednesday morning, stocks will probably see a massive relief rally with share prices skyrocketing. On the other hand, if either one of the candidates legitimately (not empty bluffing) contests the election, we could be in for a hideous period ahead, fraught with contention, declining stock prices, and potentially, violence in the streets.

Please stay safe and healthy!





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