Quick Look


A Compendium of the Most Critical Considerations for Investors This Week


 

Quick Look Market Report
When stocks and bonds are making significant moves, ETFOptimize Strategy Subscribers receive our 'Quick Look' analysis of the
most critical macroeconomic, fundamentals, and technical signals affecting today's investment markets.




Is This the Start of a Market Crash?

Note: All market analysis published on ETFOptimize reflects our interpretation of the signals of our proprietary, composite indicators – to inform your understanding of current market conditions – and should NOT be used for trading signals. Each ETFOptimize Systematic Strategy provides investors with a turnkey investment system that needs no exogenous inputs. We recommend that you follow the trades of your systematic model to the letter.

This is a SAMPLE of the August 4 Quick Look Report, which Premium Strategy subscribers receive most weekends. Subscribe today to get this and more of the Premium Strategy-subscriber-only content.


Market Incurs Significant Blow After Setting New All-Time High

After the S&P 500 set another new All-Time High (ATH) on July 24, shares were hit last week for five days in a row of intense selling pressure as the S&P 500 dropped by -3.10% and the Nasdaq 100 plummeted by -4.04%. These weekly declines were the largest since last December in the nearly-a-bear-market downturn in the 4th quarter. Last week, the best relative performer of major market indices was the small-cap Russell 2000 with a -2.87% decline, but it was still that index’ most significant drop since late-May (the Russell 2000 remains in a long-term downtrend).

Last Wednesday (July 31), the Federal Reserve dropped the target range to 2%- 2.5% for its overnight lending rate, a 25-basis point drop from the previous level. In cutting, the Fed’s reasoning included “implications of global developments for the economic outlook as well as muted inflation pressures.” The committee said that the current state of US growth is “moderate” and the labor market “strong,” but still they lowered the rate.

Many modern-day, discretionary investors have learned to behave in response to Fed rate changes like Pavlov’s dog salivating for lower rates and free money while running away from hikes. Nevertheless, that dynamic can change at any time and go the other direction when the economy begins downshifting. Is the Fed’s rate reduction the harbinger of an imminent recession? Do they know something we don’t know? Only time will answer these age-old questions, but a rate decrease this late in a bull market can’t be a good thing. Right on cue, investors sold off stocks for five days of last week, and the first half of this week.

Sector Performance

Chart 1 below shows the 11 S&P 500-based SPDR Sector ETFs accompanied by three additional ETFs covering critical segments of the market – Real Estate (IYR), Oil/Gas Exploration and Production (XOP), and Semiconductors (SMH). If we examine last week's sector performance to find those that held up – in addition to the ones that carried the market lower – well, there wasn't much that held up. Only two sectors squeaked out minor positive performance – two of the usual suspects; Real Estate (IYR) and Utilities (XLU).

One-week Sector Return
Chart 1:
Last week, 12 of 14 sectors were in the red. The only S&P sectors that were resilient were the usual suspects; Real Estate (IYR) and Utilities (XLU).



Still Near All-Time Highs (ATHs)

The S&P 500 drives bull and bear conditions for the entire market, accounting for some 80% of the market cap of all US equities – the 800-pound gorilla of the investment industry. One week does not a trend make, but further underperformance from the S&P 500 would be a significant negative for the broader market.

Chart 2 below shows a weekly chart of the S&P 500 since July 2017 in the top window, the Relative Strength Indicator (RSI) in the middle panel, and the MACD Histogram in the bottom pane. We can see that the S&P 500 has set three new all-time highs (ATH) – in January 2018, September 2018, and the week before last, July 24, 2019.

The blue arrows mark these ATHs and the upward-sloping, blue line identifies the uptrend. The S&P 500 is the only major index to have exceeded its previous 2018 high this year. Notice that with the last bar on the far right of the chart (top window), the S&P 500 closed last week at 2932.05 – just below its 10-week (50-day) moving average at 2934.33.

 

Divergences Dominate Technical Analysis of S&P 500
Chart 2: The S&P 500 set its third, significant all-time high (ATH) since early 2018. However, RSI and MACD are diverging downward, possibly a bearish omen.



Losing Momentum

While the steady recurrence of three All-Time Highs (blue arrows) in the last 1.5 years is assuredly bullish, this chart also displays some bearish omens and is starting to look vulnerable. The middle window of Chart 1 above shows that July peak of the 9-week Relative Strength Indicator (RSI) fell short of its April peak. Not by much, but by enough to create a negative divergence with the ATH of the S&P 500 itself.

Similarly, in the bottom window, we see a second warning coming from the weekly MACD Histogram bars, highlighted by a falling trendline (red). The negative divergence shown by these two indicators may be suggesting the potential for loss of upside momentum. That said, negative divergences are no sure things, and we don't use them as indicators in our quantitative strategies. They are suitable for seeing market propensities in analog charts, but not necessarily accurate for quantitative investing.

However, even if the S&P 500 does recover and head higher in the coming week, it's unlikely the well-established overhead resistance (blue line in the top panel of Chart 1) – which has been in place since January 2018 – will be pierced without a struggle. This statement is especially true in the months ahead; August, September, and October – which have historically presented a challenging seasonal period for investors.


Market Breadth Offers Valuable, Leading Signals

Breadth Indicators are used to measure the health of a group of related stocks, usually by measuring group participation in a trend. The group can be the members of a broad index, a specific sector, or even the entire market. We use a variety of sophisticated breadth measures in the ETF Selection Systems employed by the ETFOptimize Investment Strategies, including a High/Low indicator, Advance/Decline indicator, Advance/Decline Volume indicator, High Beta/Low Beta indicator, Percent of Stocks above their 200-day Moving Average, and others.

Chart 3 below is provided for illustration purposes, to show a few of these signals in an understandable analog format accompanied by the context of an S&P 500 chart. A daily, one-year chart of the S&P 500 is shown in the top window, and breadth indicators are applied to four different market segments displayed in the lower windows.

The chart of the S&P 500 in the top window shows that in late June, the S&P 500 broke above the Resistance Zone (red-shaded line) at about 2950 that had been in place since late September 2018. This zone served as Resistance at the end of the Christmas-to-May rally when the S&P 500 gained nearly 30%. Stocks pulled back after meeting that Resistance Zone around 2950 in early May, then finally broke through that level in late June. As indicated by the red-shaded line changing to a green-shaded line, a broken Resistance Zone (red) becomes a Support Zone (green) – the bottom of which the S&P 500 found itself again last Friday.

 

Breadth Offers Supplemental Signals
Chart 3: The S&P 500 is at its Support Zone, and there is still a gap between the Advance-Decline Percent and a Sell Signal for the three market segments of large-cap stocks, mid-cap stocks, and small-cap stocks (three middle windows). Stocks above their 200-day MA also remains on a bullish signal.

 

The lower four windows of Chart 3 above are Breadth Measures. In this case, the middle three windows show the Advance/Decline Percent Indicator for the S&P 500 (large-cap stocks), S&P 400 (mid-cap stocks), and S&P 600 (small-cap stocks), each using a 10-day EMA to smooth the line. The bottom window shows another Breadth Indicator, in this case, the Percent of S&P 500 stocks above their 200-day Moving Average.

For a Bullish Signal, this model uses the weight of the evidence and requires three of the four indicators to provide positive signals above either 30% (Advance/Decline %) or above 60% (% Above 200-day). A Bearish Signal requires the reverse with moves below - 30% (Advance/Decline %) or below 40% (% Above 200-day).

You can see that these four breadth indicators issued a Quadruple-Down Signal in October 2018 (identified by the red numbers #1 through #4 on the left side of the chart). This signal would have removed investors from the risk of loss that proceeded shortly after that. The next critical signal came when stocks began a significant rally the day after Christmas 2018, and three of the four breadth indicators issued a Triple-Up Signal in January 2019. The fourth Breadth lndicator (% Above 200-day) issued a confirming signal in early February.

On the right side of Chart 3 above, notice the yellow-highlighted area in the middle-three windows that are labeled 'Gap' in blue. These gaps between the current reading of the chart and the Sell Signal at -30% shows that downside participation remains limited. Last week's downturn did not move a significant enough percentage of stocks in any of the market segments (large-cap, mid-cap, or small-cap stocks) to indicate that market quality has extensively deteriorated (at least, so far). Therefore, overall market breadth still resides on a bullish UP SIGNAL from January.

 

Binary Breadth Signals for the Same One-Year Period

Chart 4 below shows an example of a binary, digital signal from one Breadth Indicator that is built into our S&P 500 Bull/Bear Strategy. This image gives you an idea of how an analog breadth chart, as displayed in Chart 3 above, might be utilized in a quantitative portfolio system and employed as part of a sophisticated, market-assessment and ETF-selection system.

 

Quantitative Breadth Indicator Signals
Chart 4: This Quantitative Breadth Indicator is one component in a 16-component Ranking System used in our S&P 500 Bull/Bear Strategy.

 

Keep in mind that the signals from the indicator shown above do not alone determine market exposure for the strategy. There are 15 other components in a composite that contribute to produce very robust and accurate signals.


Our Expectation for the Next 2-3 Weeks

For the time being, economic indicators continue to hold up, breadth continues to be positive, and the primary trend of the S&P 500 (SPY) remains bullish. This situation won't last forever, but it's likely the S&P 500 (SPY) won't fall much below its 40-week (200-day) moving average, which is where the index also found support at its late-May low.

That 40-week average should be at about 275-280 for the S&P 500 ETF (SPY), which is only about -2% below the current level of prices (at the time of this writing), so investors are likely to incur relatively limited risk before stocks turn higher again. Based on this scenario, from the all-time high set two weeks ago, investors may see nothing more than a typical correction of about -10%, with a weekly pullback to the 40-week moving average.

Chart 5 below shows this scenario for the S&P 500 ETF (SPY):

 


Chart 5: With conditions still constructive, it's likely the 40-week moving average will hold up as support for the S&P 500 ETF (SPY).

 

That said, there is still a non-zero probability that stocks could continue further downward – below the 40-week average – especially if economic indicators experience further deterioration or there is an unexpected shock to the financial system. There are several critical macroeconomic indicators, including the Unemployment Rate and the Corporate Yield Curve, that are at or near a significant inflection point. Being leading indicators of economic downturn, when these indicators do reverse course, we can expect to see equities head sharply lower as that's a signal to savvy investors that an economic recession with unpredictable consequences is about to begin.

In the meantime, investors should ignore the financial cable news, tweets about trade wars, and other nonsense. That is just day-to-day noise, and the only people for whom it might be relevant are day traders. The forces that are genuinely affecting the market's intermediate and longer-term trends are all considered by the ETFOptimize Systematic Investment Strategies.

No outside, discretionary inputs should ever be applied to a quality, quantitative investment model, and you should avoid giving attention to the day-to-day market volatility and the madness that goes on in the financial news media. The media has financial motivations that are far afield from yours!

In the words of Warren Buffett: "An investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace."

 

Strategies Made for This Precise Situation

The ETFOptimize Systematic Investment Strategies have been explicitly designed for the type of conditions we are seeing today – where significant potential threats are lingering in the distance, but if an investor pulls out of the market when things appear to be troubling, they may miss out on some of the most significant market gains. Historically, there is often a substantial increase in stock prices in the months and even years before a recession-related selloff begins. For example, Fed Chairman Alan Greenspan famously warned about "irrational exuberance" in 1996, but the market didn't top out until four years later!

Every week, our models assess more than three dozen different data series to assess conditions – including macroeconomic, stock fundamental, market breadth, and technical indicators – to determine when aggressive long ETF positions, neutral positions, or defensive ETF positions are appropriate for the coming weeks and months. That consistent, real-time assessment of conditions means that our strategies switch to the optimum holding at the optimum time – minimizing drawdowns to an average of only -11.08% per year and producing consistent Annualized Returns that average 28.71%without our models ever incurring a loss in any year since inception.*

If you're looking for defensive positioning for a challenging forward scenario, two of our Premier Strategies – the Adaptive Equity+ (2 ETF) Strategy and Equity+/Fixed Income+ (4 ETF) Combo Strategy – are already holding defensive positions and are set to profit handsomely regardless of the direction.

The Equity+ Strategy is holding two defensive, equity ETFs, and the Equity/Fixed Income+ Strategy is currently holding four, aggressive fixed-income ETFs. Here's a performance chart of the Equity/Fixed Income+ model since early June. You can see that it made hay with last week's downturn:

Equity+/Fixed Income+ (4 ETF) Combo Strategy

 

Subscribers to the Adaptive Equity+ Strategy may wish to also subscribe to the Equity/Fixed Income+ (4 ETF) Strategy for additional, high-performance diversification. Aggressive investors can break out the 2-ETF Equity portion of the model for a 38% Annual Return from a completely different set of two ETFs than is offered by the Adaptive Equity+ model (but still get similar performance and risk-adjusted return as the Equity+ model).

Check out all of the ETFOptimize Systematic Investment Strategies today!

Note: We will be revising the S&P 500-based strategies soon and will be introducing an entirely new set of models to supplement our current models over the next few months. These will include our new Sector Magic Strategy (both US and International Sectors) a true, 26-asset Asset Allocation Strategy, and more. We'll notify you as soon as they are ready!



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*When measured midyear-to-midyear (July 1 to June 30) each year.




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