ETFOptimize Insights

Data-driven Analysis of the Critical Market Indicators
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ETFOptimize Insights
Note: Our articles cannot cover all offsetting aspects of each model, nor can they provide the spectrum of aggressive/conservative differences between each model. Clients should always follow their model's published systematic decisions to the letter. Doing otherwise negates all the advantages of a systematic, ETFOptimize Premium Strategy. Copyright © 1998–2022, Optimized Investments, Inc., dba Contact us for reprint permission.



Market at
Critical Inflection Point

(Originally published as a "Quick Look" article for paid Premium Strategy Subscribers on May 22, 2022)

Note: Our articles do not cover all offsetting aspects of each model, they can only sample a few of the factors from the spectrum of variables that provide diversification between each of our Premium Strategies. Clients should always follow their chosen model's published systematic decisions to the letter if you seek to replicate its performance. Doing otherwise negates all the advantages of a systematic, ETFOptimize Premium Strategy. Copyright © 1998–2022, Optimized Investments, Inc., dba Contact us for reprint permission.





Seven Consecutive Weekly Declines for S&P 500

Last week was consequential for investors, and investment markets are at a critical inflection point.

Last Friday, the S&P 500 briefly dipped into Bear Market territory before recovering to close the day nearly unchanged from Thursday's closing price.

The inflection point boils down to this: stocks are either going to 1) bounce off the bear-market threshold it just tagged last Friday, and a rally ensues (for a while), or 2) the Fed is serious enough about tightening to whip inflation that it will destroy demand. Jerome Powell may pile policy mistake (over-tightening in the face of global economic slowing) upon policy mistake, causing a 40-year high for inflation when everyone in the world could see it being created – while the Fed denied responsibility and called it "transient."

Most indices other than the S&P 500, such as the Nasdaq 100 (QQQ), the Russell 2000 small-company stocks (IWM), and 10-Year Treasury Bonds (IEF), are already in bear-market territory, defined as a decline of more than -20%. In fact, the vast majority of the market is in bear market territory. The S&P 500 is the equivalent of the "last man standing."

Also, on Friday, the S&P 500 recorded its seventh consecutive weekly decline. The last time we saw a decline lasting seven consecutive weeks for the S&P 500 was 21 years ago, and there have only been three times previously in history. The coming week looks favorable (or unfavorable, depending on your perspective) for an eighth straight weekly decline for the S&P 500. The Dow Industrials (DIA) experienced its eighth straight weekly decline, marking its longest losing streak since April of 1932.

The S&P 500 has always been a shining symbol of the success of American capitalism, so the headline at the top of this section feels incongruent with that image. However, the world's image of the US economy is not what it used to be, with sky-high inflation and enormous policy errors taking the luster off America's reputation as the business world leader, on the cusp of a relentless decline.

While the US economy still seems to be percolating, investors should heed the many warning signs. The first warning is the stock market itself. While many investors look to the economy as an indicator for their investment plans, that approach is 180º backward. Instead, the market (S&P 500) is one of the best indicators for the future of the US economy by about 6-9 months. The market says that the economy is getting ready to tank, probably by this summer, if not before.


A Rarity: Seven Consecutive Weekly Declines

Chart 1 below shows the incidence of seven or more consecutive weekly losses for the S&P 500 in the last 94 years since the S&P 500 index was created in 1928. The last time the S&P 500 recorded seven weekly losses in a row was in 2001, in the first year of the Dot-Com implosion.


Seven weekly declines for SPY
Chart 1: The S&P 500 Index ($SPX) has now had seven consecutive weekly declines, a rare milestone. Source: Bloomberg Finance.


Newer investors have no idea how bizarre it is to see stocks decline seven weeks in a row. Moreover, those seven weeks of declines are impacting nearly every corner of the equity market. A quick analysis of data that's current this weekend shows that fully 88% (2,263) of investable ETFs (2,571) have declined during the last seven weeks. This year, the number of individual stocks, bonds, and ETFs losing money is breathtaking. This is your government at work...

Suppose we excuse a slightly positive week that slips in here and there in the list of relentless seven-week declines. In that case, that losing-ETF list includes the Dow Jones Industrial Average (DIA), the NASDAQ Composite (COMPQ), the NASDAQ 100 (QQQ), the SPDR Technology Sector ETF (XLK), the SPDR Consumer Discretionary Sector ETF (XLY), the Industrial Sector (XLI), Communications (XLC), Retail (XRT), Transportation (IYT), Financials (XLF), and the list goes on and on...


The Downturn May Be Accelerating, Not Slowing

Critically important, while there was a significant amount of inflows last week into beaten-down sectors (Cathie Wood's disruptive ARKK Innovation ETF received $1.3 billion of inflows even though it lost -75% in 2022) from investors expecting a rebound rally higher, the downtrend in the market may be accelerating.

Chart 2 below shows the rare seven weeks of declines in the S&P 500 ETF (SPY) mentioned above and displays the 5, 10, 15, and 20-week moving averages (blue, red, green, and pink). The fact that these lines are widening indicates that the pace of the downtrend is continuing – perhaps accelerating. Last week's decline was -3.01%, more than the previous week's -2.34% and -0.16% the week before. Also, notice the significantly steeper decline angle now than what we saw in January and February.

Downtrend Accelerating
Chart 2: The SPDR S&P 500 Trust (SPY) has declined for seven consecutive weeks, potentially accelerating downward.


It seems logical to think that a seven-consecutive-week market decline is undoubtedly overdone, and the S&P 500 has likely reached an oversold level with consumer and business confidence reaching historic lows. However, you would be wrong in that assumption. Because the selloff of investment markets has been very consistent and steady, relative strength is not yet overdone to the downside. Weekly RSI is still above 30 – bearish but not yet oversold.

The Power of the "Invisible Hand" (of Economic Engineering?)

What could cause such an unrelenting – yet smooth and consistent – downturn of the equity and fixed-income markets? Today's well-disciplined smoothness of the equity curve reminds me of a similar stretch not long ago, when the S&P 500 was in another steady and low-volatility trajectory – but this time, it was moving in the opposite direction: consistently higher (and for far longer, at ten months).

Those ten months comprised the red-meaty bulk of the bull market rally, when the S&P 500 logged its most significant gains, driven by the steady infusion of $120 billion per month in new Money Supply (M1 and M2) created by the Federal Reserve.

Do you recall that for most of 2021, the S&P 500 barely budged off its consistently upward-climbing trendline? Nothing could move that market off of its straight-line (and rapid-paced) progression higher. Why? Because equities were being manipulated upward by the "invisible hand" of one, specific market force. That market force was one that rarely played a role in the invisible hand theory.

Today, it's a different story as America's monetary authority, the US Federal Reserve Bank, is playing a rapidly growing role in sustaining the free-market economy of the US. The phrase "Free-Market Economy" is specifically about an economy that is free from too much government interference and intervention.

Chart 3 below shows the incredibly smooth, low-volatility rally from November 2020 to September 2021. Those ten months of post-Covid-Crash bull market conditions were fully-fledged market manipulation at its finest. Today we're five months into a reversal of that policy, and perhaps we'll experience an equally consistent 10-month decline downward. It's not like Fed Chairman Powell hasn't been warning us.


Steady Fed stimulus fueled the most consistent bull rally in history
Chart 3: Because of their mega-cap stocks, the S&P 500 and Nasdaq 100 were the primary beneficiaries of Trillions of dollars of free money.


Perhaps you remember the "invisible hand" from your Economics 101 class in college. The invisible hand is an idea that Scottish philosopher and economist Adam Smith introduced in his 1776 book, "An Inquiry Into the Nature and Causes of the Wealth of Nations," often shortened to "The Wealth of Nations." Smith used an imaginary hand as a metaphor for a force working in free-market economies that manipulates otherwise self-interested business people to work together and with other parties to achieve mutual objectives.

However, in the early years of the 21st century, it's an invisible hand not of capitalism or market forces, but the invisible hand of a "command and control" government system, not far removed from how the Chinese manipulate their economy.

As you may have surmised, I'm not advocating for the Federal Reserve to get more deeply involved with determining winners and losers in the American free-enterprise system. The Fed is now expanding its influence by regularly dealing in amounts represented by various numerals followed by the word Trillion — as in, "The Fed's Balance Sheet now stands at the breathtaking level of $8.9 Trillion." (Some may notice I've been capitalizing the word Trillion in recent years to distinguish this absurdely large amount, which is truly… well… breathtaking...)

Since investment dollars, through the magic of compounding, grow at an exponential, geometric rate, this outcome has always been inevitable (although I didn't anticipate it would happen in my lifetime.). Ray Dalio, founder of the Bridgewater Capital (a Connecticut hedge fund) has has spent years studying the detailed history of the rise and fall of the most significant empires over the last 500 years. These empires include the Greeks, Romans, Scandanavian/Dutch, Spain, England, and since 1945, the United States.

Dalio has identified, late-stage empires tend to rely more on increasing Money Supply and less on increasing productivity and innovation to drive their growth.

Dalio believes America is in a late stage of the empire cycle, which he concluded after several years of studying more than 500 years of world history. and writing an excellent book: "Principles for Dealing With the Changing World Order." He realized that he was seeing things change with the election of Donald Trump. These events, such as the rise of populism, the tension with China, or partisan political polarity had never previously occured during his lifetime, but he recognized them from the historical record.

Throwing up our hands and giving up because things are changing negatively is not his prescription. Mr. Dalio advocates learning about how things have changed many times in mankind's past and using that information to profit today. He has also said that now that we have such a long and complete historical record, we can take the lessons of the past, and use them to try to change the course of history. Dalio believes that America has started down a path that will lead to self-destruction. But that's not necessarily the path we must continue on. We can change the course of history by consciously changing our path.

Let's examine the new environment we're facing and determine how to turn insights into investment profits...

Fed Causes Unusual Performance Regime

That rally through the Spring and Summer of 2021 was the cause of tremendous frustration at ETFOptimize. Our quantitative Premium Strategies, tuned with fine craftmanship to identify and avoid market risk over the last 24 years that we've been offering rules-based strategies, underperformed during the rally off the Covid Crash. Up until January this year, when their risk-averse defensive choices were finally appropriate, we were not entirely happy with our model's performance.

Over the last two years, the relative underperformance directly resulted from the Federal Reserve artificially manipulating stock prices higher from March 2020 to the end of December 2021. Our systematic strategies operated appropriately during that stretch to identify times of increased risk and reduced market exposure for brief periods. However, as we see from Chart 3 above, there was never an appropriate time to reduce exposure to the market. In fact, if ever there was a perfect time to own a triple-leveraged ETF based on the S&P 500 or Nasdaq 100, the span shown above in 2020 and 2021 was it!

However, legitimate systematic investors avoid modifying strategies that are established and successful. If they underperform, it's usually for a very short time, and we should ignore it. However, conditions have now fundamentally changed for investors, and there is no going back. Investors must adapt to these conditions to survive and thrive in the brave new world we face in the future.

For example, even when our models were bullish during the span shown in Chart 3, they avoided the most aggressive ETFs and leveraged positions because both stocks and bonds were obscenely overpriced (near the 2000 Dot-Com-Bubble PE high). Nevertheless, with the Fed forcing $5 Trillion into the financial system and increasing the US Money Supply to boost economic activity, equities and bonds behaved dissimilar to anytime in history, disregarding elevated risks and climbing ever-higher as a result of the profligate creation of Trillions of dollars of new money by the Fed.

The straight-line bull market during the summer of 2021 (shown in Chart 3 above) is eerily similar to the current very-steady downturn (shown in Chart 2 above) – except that QT (tightening) is causing an opposite mirror performance of QE (easing). The Fed was creating a steady stream of incredible amounts of money out of thin air in 2020-2021, and most of that "free money" was indirectly deposited into the stock market's "account" through a complex process that I won't go into here.

However, now the Fed is telling us that its policy is to withdraw all that stimulus money, reversing the process of accumulating Treasury Bonds. With its track record, I tend to believe the Fed when it promises to do things detrimental to the American economy. It's been highly successful at blowing things up throughout history.

Flirting with the Bear

Last Friday (May 20), the SPDR S&P 500 ETF (SPY) briefly traded into bear-market territory before recovering 2.39% to finish the day slightly higher (0.04%) than Thursday. The most popular trading vehicle on the planet (131.4 million shares changed hands on Friday), SPY briefly dropped to a mid-day low of $380.54 in the morning, which is -20.12% from its all-time high at $476.37 on January 3.

Chart 4 below shows a one-day, 5-minute candlestick chart of the S&P 500 ETF (SPY) from last Friday. The ETF traded sharply higher in the first five minutes but then steadily dropped throughout the morning. By 1:30, it had reached 380.54, which is 44¢ into Bear Market territory (red-shaded area on chart). On a closing basis, a -20% decline from its All-Time High (ATH) on January 3, 2022, at 476.23 establishes Bear Market territory at 380.98 and below for the S&P 500 ETF (SPY).


SPY Flirts with a Bear Market
Chart 4: Friday, the S&P 500 ETF (SPY) flirted with Bear Market territory. Investors should be careful dealing with such a fearsome beast.

After touching in Bear Market territory for five minutes around 1:25 PM, investors started buying SPY again, the stock reversed higher, and algorithmic trading programs probably jumped on it. The world's most popular ETF (SPY) climbed back to even at Thursday's closing price.

You can't argue that the chart above is not bullish in the very short term. SPY closed out the week with ten consecutive positive five-minute candlesticks, and it remains 2.23% above its bear-market territory at about 381.

A significant contingent of investors believes the market can rally higher from here—pouring hundreds of billions of inflows into aggressive Equity ETFs, such as SPY or even ARKK. After seven weeks of declines, many are trying to call a bottom here. The Dow Industrial Average has experienced its most prolonged decline since 1932! With its PE ratio back below 20, many think the S&P 500 is undervalued.

Whether stocks will go up or not is another matter altogether…

Is a Rally Back to New Highs Possible?

So far, nearly all of our proprietary composite indicators are telling us the broad market (SPY, QQQ, IWM, etc.) remains exceptionally bearish, and we should avoid it.

However, last week, tens of billions of dollars of new money came into market segments that were bullish in 2020. This money came from investors who believe that conditions are not as bad as they might seem. The past winners have been beaten down so much that they are new opportunities. One example is ARKK, an ETF run by Cathie Woods that owns innovative, disruptive companies, which saw $1.3 billion in new funds deposited. 

Some believe that Fed Chairman Powell is "all talk." Ultimately, he won't follow through on his threats to be a Paul-Volker-like figure. Volker was the Fed Chairman in the late-70s/early-80s and took a machete to the market by raising interest rates to nearly 16% in 1981 to battle inflation. So far, the Fed has raised interest rates by only 0.75%!

One of the Fed's two assignments is Price Control, and the other is Full Employment, so controlling inflation is one of Chairman Powell's mandates from congress. He has no choice in the matter. He can't be flexible and choose to put off controlling inflation. He will indeed be impeached from office if he did that when so many Americans are suffering from inflation. 

While we could see a powerful, reflex rally in the next week or two, bear-market rallies can greatly damage investors. Stocks will climb until they look like they are headed back to prior highs and more and more investors get involved. After some time going up, many investors will jump in with both feet, confident that the Bear Market is over. But that's when it can bite the hardest. So far, SPY hasn't spent a single day in Bear Market territory in 2022, but market fundamentals and economics are extremely bearish. The Fed has had the back of equity and bond investors for the past 14 years, but now that support is gone.

Nevertheless, after a week or two of climbing sharply higher, when investors say, "Damn! I've been missing out on a sure-fire rally! I should have continued buying the dip because it worked for me for the last two years!" 

FOMO or "Fear of Missing Out" is when upside capitulation occurs, and the masses dive back into stocks at the worst-possible moment. It is almost always a classic case of Buying High and Selling Low – So please be very careful in this environment!


Potential Downside Possibilities

Our indicators show that the long-term trend of the market is down. So let’s look at some levels where the S&P 500 might stop falling – and a bull market gets back underway.

Chart 5 below shows two of the most likely potential downside levels that align with prior market highs and lows. A basic tenet of technical analysis is that prior critical levels will attract significant crowding in the future, making them viable support or resistance levels, depending on whether the ETF is climbing higher into Resistance – or, as is the case imagined here – falling and stopping at a prior Support Level created by a past high or low threshold.


Chart 5: The S&P 500 Index since 1992 shows crucial past levels and how far the market could fall if the Fed succeeds in creating a bear market.



High-Probability Support Levels

Chart 5 above shows the S&P 500 stretching back for 18 years, so this chart includes the start of Quantitative Easing (QE) in September 2008. Take an overall perspective of Chart 5 above and observe the effect of QE on the market.

Now imagine that the Covid Crash did not happen. It was a strange event that surprised everyone, including the Fed, but the Fed initially responded to Covid well. However, as time went on, we can see that the Fed's long-term game-plan has poorly planned. The Fed vastly overstimulated, causing the high-inflation situation that's shredding the social fabric of the US and the world.

Then also, imagine if both the 2022 Decline and the Covid Crash were not in the picture. The Fed's QE program has profoundly affected the US capital markets, elevating stocks with a constant "Fed Put" – a constant support of market prices. The upward influence of the Federal Reserve's manipulation of equity prices provided investors with the confidence to consistently buy the dip, knowing that the most powerful institution on earth had their back.

The Fed would not allow the overall US stock market to enter into a bear market (a decline of more than -20%) from 2008-Present. That support insured that investors would experience a wealth effect – making Americans feel wealthier, willing to spend more money, and lifting the economy.

The Fed will begin winding down QE in June 2022 after over-stimulating during the years after the Covid Crash, and the effect of that slowdown/reversal has been profound. Expect more severe conditions ahead.

The decline of the Covid Crash was -34% in 2020, indicated with the orange span. The Covid Crash gets a dashed-blue line at both its high and its low because it was the most recent selloff and carries the greatest influence. There are additional levels below, but lets cross that ugly bridge only if we get to it.

Since its January 3, 2022 All-Time High (ATH) with the S&P 500 Index ($SPX) at $4,796.56, the S&P 500 has declined -18.94% at Friday's close. To reach the first dashed-blue level at 3,386, matching the February 2020 pre-Covid peak, the S&P 500 would need to fall another -12.84%. That's a total of -29.41% from the All-Time High (ATH) on January 3.

If stocks were to decline to a level that matches the S&P 500's Covid Crash bottom, they would fall a total of about -54% from the January peak and about -35% below today's level. I provide these two levels to show you what you may want to have in mind for the bottom of the current selloff. The ETFOptimize Premium Strategies will be minimally affected by these selloffs.

While today or this week the market may surge sharply higher, it's likely that the downturn will resume as soon as the Fed begins Quantitative Tightening in the first week of June (in 1.5 weeks). Please be aware that your rules-based model will counteract this decline. The new models we are introducing in June will perform even better. However, it's good to realize what is in store so that you aren't surprised by a sharp selloff, and you don't make a knee-jerk decision to sell your shares and sit on the sidelines.

The volatility and whipsaws this year have had a detrimental effect on our models. We could not use profitable, longer-term Fixed-Income ETFs (such as TLT or IEF). Those ETFs were critical risk-off components for three of our Premium Strategies. Our new models will address this issue and not rely on an asset that (at best) will have a flat return for years to come.

This week will likely be a critical Inflection Point, and we could see a March-like sharp rally higher in the S&P 500 (SPY) and Nasdaq 100 (QQQ) over the next few weeks. On the other hand, we might also see a steep, waterfall selloff, as we discussed last week. Personally, my intuition is that the S&P 500 will likely rally this week, then fall sharply the following week. However, in volatile market conditions like this, the last thing you want to do is chase the market.

Our models are well-positioned with a high amount of cash in our ULTIMATE Strategy, and on Monday, it will move more funds into a cash-proxy ETF (BIL), now at about 42-44% of our Ultimate Portfolio. A cash proxy ETF can be your best friend at Market Inflection Points. Stay the course, follow your model, avoid risk, and you'll do well.





For SUCCESS with a Rules-Based, Data-Driven Investment Model, PLEASE FOLLOW YOUR STRATEGY'S GUIDANCE 100% – Don't SECOND GUESS your Emotion-FREE Model!

Investor’s all-too-human emotions and subconscious biases relentlessly sabotage their investment results. Trying to follow the news or any other discretionary, judgment-based approach will only exacerbate these underlying challenges, invariably causing investors – whether amateur or professional – to buy after a stock has been rising (high) and sell near the bottom (low), capitulating to avoid losing more. Buying high and selling low attains the opposite result of a classic successful investment approach.

A carefully crafted, systematic investment strategy will eliminate these issues — BUT — you must follow your strategy's recommendations without second guessing them! Execute your strategy's trade recommendations TO THE LETTER if you wish to succeed and match your model's historical and prospective results.

That doesn't mean every trade will be a winner, and the selections will often be counter-intuitive – or they might go against the current generally accepted "wisdom" of the market. However, the probability that you'll succeed reach your long-term financial goals is far greater if you use a scientifically tested, rules-based strategy.

The ETFOptimize Premium Strategy lineup doesn't collectively (across six models) have a record of more than 100 consecutive years of profitability without a good reason:

Rules-based, data-driven investing works!

However, it only works... if you work it as designed!



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