Note: All market analysis content published on ETFOptimize reflects our interpretation of the signals from our proprietary indicators and other measures. However, you shouldn't use this content for trading signals – but preferably, only to assist in your understanding of current market conditions. All ETFOptimize Strategy holdings are determined solely by the proprietary investment algorithms used in our systems, without the influence of discretionary judgment. The ETFOptimize Strategies provide you with an investment system that needs no additional outside input, and we recommend that subscribers follow the trades of their systematic model to the letter.
Last week we launched a new Quick Look Report design, which, going forward, will provide you with a more consistent presentation for our executive-summary-style subscriber resource. We publish the Quick Look Report (or 'QLR') most - but not every - weekend. Please see the December 2 issue for an explanation of how the design and content of this feature have changed.
Summary of Market Week Ending Friday, December 6
As shown by the list below, the most well-known market indices were off slightly last Friday over the prior week. The S&P 500 bucked the trend with a minuscule gain of 0.18%.
Dow Industrials (DIA): -0.09% to 280.70
S&P 500 (SPY): +0.18% to 314.87
Nasdaq (QQQ): -0.05% to 205.00
Russell 2000 (IWM): +0.65% to 162.82
However, these slight changes from the prior week don't begin to indicate the volatility investors experienced. The big news is that many investors feel they dodged a bullet early last week. Instead of continuing a downtrend that apparently felt to many like the beginning of a significant selloff, stocks gapped higher twice last week, and we received what historically has been a very bullish technical signal. Here's what happened:
Last Monday morning (December 2), the S&P 500 dropped a full -1% from Friday's close before posting a slight recovery in the afternoon, finally finishing the day down -0.86% for the day. This price action made for the third day in a row of losses, and investors were feeling skittish after the sharp pullback following the previous Wednesday's all-time high (ATH).
Then, at Tuesday's open, investors experienced some serious pucker time. Tuesday morning provided a breathtaking continuation of Monday's decline, with the S&P 500 falling another -1.4% before recovering a bit (23 points) at the close. At the low last Tuesday, the S&P 500 was down a full -2.4% in less than a week, and other indices were down -2.7% to -3.5% from the previous all-time high (ATH) on Wednesday, November 27.
Fortunately for those skittish discretionary investors, following the -2.4% decline in less than a week, a recovery began in earnest on Wednesday, December 3. We'll take a moment here to show you a chart so you can have visual guidance as we discuss the price moves.
Chart 1 below shows a 30-minute chart for the SPDR S&P 500 ETF (SPY) for the last two weeks. While the S&P 500 and other indices finished flat compared to the prior week, those numbers are misleading because there was intense price action during the last five trading sessions.
Chart 1: Gaps, gaps, and more gaps. The flat week-to-week performance numbers don't come close to revealing how much volatility stocks experienced last week.
Pucker Time for Many Investors
After declining -1.4% from the previous week's all-time high (ATH) through Monday's close, the SPDR S&P 500 ETF (SPY) gapped down by nearly another -1% and continued down for the first two hours of Tuesday morning. Discretionary investors who were long the market began to question their judgment, as fear began to overtake them, and many pushed the SELL button on their broker's website interface.
On Tuesday, many discretionary investors who 'hung in there' felt that the market saved their cheese, as it began to climb a bit – in a choppy fashion – from the morning low, and gained 0.7% by the end of the day. Many traders breathed a sigh of relief when they saw the selloff had at least paused. At least – they reasoned – there was a short-term break so they could gather their thoughts. However, then things changed dramatically again on Wednesday and Friday.
Critical Gaps Create a BULLISH Island Reversal Pattern
At Wednesday's open, bargain-investors jumped in with both feet, and the market gapped up by 0.62%. The rest of Wednesday and Thursday saw the S&P 500 stay flat at around 312 – which was the critical level it left off at before the Tuesday Gap Down occurred.
Friday resumed the bullish, Gap Up party in earnest, with the S&P 500 (SPY) jumping another 0.67% higher to open at 314.12, then stayed mostly flat for the rest of the day. For the week, the S&P 500 ETF (SPY) closed at 314.87 – a gain of 0.18% for the S&P 500 ETF (SPY). This minuscule gain belied the implications of the gapping action last week.
After the November 28 all-time high (ATH) and the subsequent decline, Tuesday-morning's gap down is usually considered to be an exhaustion gap and represents the last gasp at the end of a downward trend. However, if it was an exhaustion gap, it is quite unusual that one occurred after only two days of a downtrend.
A day later, we saw a substantial gap higher at Wednesday's open. Then, on Friday, we saw another gap higher – which may have been a breakaway gap – and confirms the idea that what we saw the week of Dec. 2-6 an Island Reversal pattern. Island reversals are market phenomena that usually signal a bullish market turn ahead.
The two crucial levels that were established last week for the S&P 500 were 312 and 315. Watch those levels this week to see if they become the new levels of support – or if we see a near-term top and consolidation after the recent gains. However, the island-reversal formation is typically very bullish, and we can likely expect that outcome in the coming weeks.
Best Sector: Real Estate 0.50%
Worst Sector: Consumer Discretionary -0.78%
Chart 2: S&P 500 Sector relative performance for December 2-6 features the Real Estate sector (XLRE) leading and Consumer Discretionary (XLY) in the rear.
Important to note on this chart is that Consumer Discretionary stocks – which is a sector that consistently climbs at the beginning of business cycles – is the worst performer. Meanwhile, the ETFs on the right-hand side of the table, which represent defensive ETFs that usually thrive as we approach the end of a business cycle (recession), was the primary choice of investors during last week's turbulence.
The Financial Sector is a regular outlier of this rule of thumb, and its performance usually reflects idiosyncratic changes in interest rates, which can happen on a relative basis at any time of the business cycle. However, Financials often rise during periods of climbing interest rates (which provides banks with higher profits), and therefore, it's very interesting that Financial Sector stock prices are rising at this juncture. It may be a bullish signal.
Checking-In On the Long-Term Support Line (LTSL)
It is prudent to regularly check on the status of the market in relation to its Long-Term Support Line (LTSL), and we will do that briefly today. The reason we regularly check this relationship is that it provides a high-confidence marker for the beginning of Bear Markets.
Historically, Long-Term Support Lines form below every substantive, secular market move since the late 1800s. When these lines are pierced to the downside, it can provide an accurate indication of a market top and the beginning of a Bear-Market decline.
Chart 3 below shows the previous two of these long, secular market rallies (1996-2000 and 2003-2007), as well as the current bull market, which is the longest on record after forming in late-2008. Prices form a steadily-climbing, diagonal Support Line that lasts for many years during each business cycle. If this line gets pierced to the downside – and a breakdown in stock fundamentals accompanies that puncture – it is a clear and accurate indicator of the beginning of a Bear Market.
Chart 3: The Long-term Support Line is shown by a dotted-greenline, with the S&P 500 index in black. When stock prices drop below the LTSL, look out below!
Notice that we did see the LTSL broken to the downside at the end of 2018. However, stock fundamentals continued in a robust uptrend at the time, so we knew that it was only a temporary price anomaly that would soon resolve.
While many prominent investment advisors were calling for the beginning of a Bear Market (based on considerations that usually didn't include technical considerations), ETFOptimize predicted in an article at the time that we would again see new all-time highs in the coming months.
Documentation of this claim? See our November 25, 2018 'ETFOptimize Insights' report (fifth paragraph):
|"At this time, the indicators we use are telling us that there has been no underlying, macroeconomic or fundamental reason for the selloff. It is 100% technical in nature and is related to the completion of a significant market cycle. Upon completion of this leg of the technical cycle (perhaps in another month and another -10% – give or take), investors should expect a powerful and robust six-month bull rally to return stocks to their September 2018 highs and beyond."
– ETFOptimize Insights, Nov. 25, 2018
Besides the prediction of coming new highs within months while in the middle of (what for many was) a frightening selloff, in that article, ETFOptimize also predicted that investors would see another -10% down, and that's exactly what happened the following month (December 2018).
How were we able to provide this much accuracy to subscribers? The reason is that we combine fundamental, techncial, sentiment, and macroeconomic indicators into a weight-of-the-evidence decision matrix that provides accurate signals throughout the various phases of the business cycle.
Chart 4 below shows a zoom into the last five years (2014-present) of Chart 3 above. One of the most critical aspects we would like to point out to you in this chart is the fact that prices no longer have enough juice to elevate a significant distance above the LTSL. Reference the far-right side of Chart 3 above, and you'll notice how much closer prices are staying to the Support Line than they were in previous years. This is made more apparent on the right side of Chart 4 below.
Also, notice in Chart 3 above what happened with prices at the end of the bull market in the late 1990s and early 2000. Stocks demonstrated a similar pattern of difficulty gaining elevation above the LTSL before falling through and transforming into a bear market.
Chart 4: Zooming in on the last five years shows that stocks are bouncing close to the LTSL without gaining much height, reflecting slowing economic growth.
So what is the status of those fundamental stock indicators right now? We'll answer that question in the next section – and elaborate in a special report that we'll publish soon.
Fundamental Indicators Continue to Signal Bullish Conditions
At ETFOptimize, we do not depend on one, two, or even a few indicators to determine our market exposure and ETF positions. Nor do we develop emotion-driven conclusions based on predetermined beliefs, and then find the data to support those conclusions. Instead, we rely on a carefully crafted and extensive library of indicators that have a robust and consistent track record of correlation with changes in market prices.
While ETFOptimize combines as many as 38 different data sets in our quantitative strategies to determine market exposure and ETF selection, two of the critical fundamental indicators used by our models are Employment and Earnings. In this Quick Look Report, we will briefly review those indicators here, and we'll explore them in much more depth in a subsequent report.
As most investors know by now, in the pre-market hours last Friday, the Labor Department issued the US Employment Report for November. This turned out to be the best report since last January and is likely responsible for the gap upward at the open on Friday. This brief analysis will go beyond providing the raw numbers reported, and look at the signal our algorithms issued based on those raw numbers.
The Bureau of Labor Statistics surprised analysts and investors by reporting that the US economy had added 266,000 jobs in November – nearly a 50% surprise over the 180,000 jobs that economists expected. This number includes 41,000 General Motors employees who came back to work following a strike, but even subtracting out those workers, the figure remains impressive.
Moreover, October's jobs report was revised to 156,000 jobs added – up from the initially reported 128,000. Wage growth hit 3.1%, which was slightly above economist's expectations. The unemployment rate dropped back to 3.5% – where it was in September – and the lowest level since 1969.
Chart 5 below shows the ETFOptimize $MT01-Unemployment Rate Indicator, which is a macroeconomic signal system based on the delta of changes in the growth of the Unemployment Rate. That signal is currently bullish (drops to zero are bearish):
Chart 5: Our $MT01-Unemployment Rate Indicator tracks significant changes in the unemployment rate that are correlated with economic downturns.
Note that we do not rely on this indicator or any other single indicator to determine exposure to market risk. We use an ensemble of indicators to improve signal generation and avoid strategy fragility.
We use a unique calculation for S&P 500 Earnings that combines the trailing-twelve months (TTM) Reported Earnings, the Current Year (CY) Earnings Estimates, and Next Year (NY) Earnings Estimates with a multi-stage algorithm that progressively blends in more of the CY and NY Estimates as the year progresses and analyst's estimates become more accurate. This more closely reflects investors judgments We call this indicator our $MT09–S&P 500 Progressive Blend Earnings Composite (SP500-PBEC).
Chart 6 below provides the $MT09-SP500-PBEC as a red line, with the S&P 500 ETF (SPY) in blue. Notice how changes in the trend of the indicator provide a slightly leading signal for changes in the S&P 500's prices.
Chart 6: Our $MT09–S&P 500 Progressive Blend Earnings Composite (SP500-PBEC) is shown from 2000-present.
Chart 7 below shows a zoom into the last five years of our SP500-PBEC. We can see that, other than a shallow dip that coincides with a brief – but intense – 19.8% downturn in the fourth-quarter of 2018, and turbulence from the 2015 Earnings Recession, S&P 500 Earnings have followed a reasonably consistent, but rather tepid, uptrend since early 2016. This tepid uptrend is reflective of the slow pace of global growth this late into a business-cycle expansion.
Chart 7: This chart displays a zoom of our $MT09-S&P 500 Progressive Blend Earnings Composite (SP500-PBEC) for the last five years.
While there is a possibility of a quick technical correction to burn off enthusiasm and take profits from the recent gains, stock fundamentals and market technicals both support a continuation of the uptrend at this time. We advise our subscribers to follow the recommendations of their Premium Strategy to-the-letter – and all of the models are bullish at this time.
Overriding your model's recommendations with discretionary judgments or "waiting for a dip" is a well-worn path that eliminates the many benefits you receive from a quantitative investment model, and over time, will guarantee that your results return to the average for all discretionary investors – about 2.6% per year – compared to 77% average AR in 2019 for our top two strategies.
As of December 11, 2019
KEY: The blue line shown is the benchmark: a 70%-30% weighted, buy-and-hold of the S&P 500 ETF (SPY) / and Total Bond Market ETF (BND).
The red line shows the "Optimal Equity/Fixed Income (4 ETF) Combo Strategy's" performance for 2019, with a return to Nov. 11 of 63.39% and a CAGR of 78%.
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