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.
Investors Stay Focused On the Essential
Despite all the distractions and turmoil in 2019, investors kept their focus on what's essential – the earnings of publicly traded corporations and the macroeconomic health of the US and world economies. One hundred years from now, for a historian reviewing today's stock charts for signs of social disarray, the tempests mentioned above from 2019 are nowhere to be found in the bull market that has been roaring since the post-Financial Crisis secular bottom on March 9, 2009 – or the most recent leg higher – which began on Christmas-eve, 2018.
The S&P 500 logged 52-week highs in six of the last nine months, surging 17.7% in the first four months alone. Half the components of the S&P 500 are up 10% or more from May to December, with 93 stocks up more than 20% during the same period. Since the December 24, 2018 low following that year's fourth-quarter, -19.8% selloff, the S&P 500 ETF (SPY) is up a whopping 40.38% to-date.
2019 also proved to be an excellent year for the ETFOptimize systematic models, with our best-performing, the Adaptive Equity+ (2 ETF) Strategy recording in a return of 72% on the year. Moreover, the Equity++ Component of our Optimal Equity/Defensive (4 ETF) Strategy recorded a phenomenal return of 96% for 2019, while the complete 4-ETF model gained more than 66% for 2019. To learn more about these phenomenal performances, see this recent 'Inside Secrets of Investing' Blog article.
After the calendar turns, we will put together a post-2019 review of our models, while also announcing the rollout of the revisions to our S&P 500-based models that provide significant improvements, and new models that are sure to put a subtle smile on investor's faces when they see the details. Our designers believe they have created a breakthrough for the investment industry in these latest refinements, but we will let the investing public be the judge of our work in the years ahead, with each model's performance doing the talking.
All that good news aside, we may be seeing the set up for a déjà vu prediction of "Too Far – Too Fast" for stocks in the coming weeks (more on this in a moment).
Equities Getting Extremely Over-Extended Above Their Long-Term Mean
Chart 1 below shows the weekly prices of the S&P 500 ETF (SPY) relative to its 40-week EMA (dotted-blue line). This 40-week level is equivalent to the 200-day moving average or the 10-month moving average, a threshold that millions of investors regularly monitor at a glance to determine whether market conditions are bullish or bearish and whether they should hold or sell their equity investments. We can logically consider this level to be the market's long-term mean – and as we have stated many times in these pages, the stock market is a mean-reversion machine.
That highest watermark above the long-term mean (marked #A) on the 2.5-year chart below occurred after SPY extended to a level of 13% above its 40-week EMA for the week ending January 26, 2018. This high came as investors fed off one another in the profit-giddiness following the historic corporate tax cuts enacted by the all-Republican-branches of US government in December 2017. Those tax cuts paid off as anticipated with demonstrably increased corporate earnings over the subsequent 9-10 months, piled atop already-record-level profit margins.
Nevertheless, while the sugar-rush of continuing new stock-price highs has rewarded investors, corporate profit growth has slowed to a crawl. Yet, equity prices continue to climb at a rapid pace – establishing increasingly expensive conditions for new purchases. At some point, investors are going to put on the brakes – but not until they've made just… a… few… more… percent.
Notice in the lower window of Chart 1 below that at #A, the weekly Relative Strength (RSI) reached a high of 92.27 that coincided with a parabolic sky-shot of stocks as they elevated 13% above their long-term mean following the December 2017 tax cuts.
Chart 1: The S&P 500 has reached an all-time-high (ATH) that is currently 9.1% above its long-term mean at the 40-week EMA. Weekly RSI is at a nosebleed 76.
In the lower window, we've marked each new-high RSI event above 70 with a red down arrow that matches the ATH of prices in the top window. Before the selloff began, we predicted it – in a January 20, 2018 blog article titled "Too Far, Too Fast!" – and the selloff began (just as anticipated) less than a week later.
Most importantly, our systematic models anticipated the event and sidestepped the sharp losses that many investors experienced. And every percentage you avoid losing is 1.5% to 2% you don't have to make to get back to even.
While some might reason in 20-20 hindsight that they could have seen the losses when they were occurring and sold their positions – or as is often claimed – a stop loss would have ended the bleeding. However, that's not necessarily the case. In a cascading downturn, as occurred after the January 26, 2018 high, it can be nearly impossible to close out a position when there are far fewer buyers on the other side of the trade. For example, in the 2008 crash, we saw media reports that some trader's stop losses got violated on a Monday, but a close of the position didn't occur until Thursday – when buyers surfaced, but not until after incurring losses of -25% or more.
The analysis we did in that "Too Far, Too Fast" article was a write up of the signals registered by our quantitative investment strategies. Remember that you should not interpret this content for discretionary investment decisions that override your model. To ensure success, please follow the recommendations your model to the letter. 77 of 77 collective, profitable years can't be wrong!
Following the parabolic climb to a high at #A in the chart above, the S&P 500 then began a two-stage waterfall decline that saw the ETF drop precisely to the same level as its 40-week mean (at about 250) in mid-March 2018. Then the S&P 500 began a six-month climb to a new all-time high (ATH) in early-September 2018 that was 7.2% above the long-term mean, followed by a frightening fourth-quarter selloff with close to a -20% decline, culminating with the December 24, 2018 low at about 235 (at #B, above).
Throughout Chart 1 above, we can readily observe how the S&P 500 would repeatedly move too-far, too-fast above its 40-week EMA (dotted-blue line), then reliably drop directly back to that level in rapid fashion before beginning to climb again. Each time stocks reached a new high, it was usually at an average of about 7.3% above the long-term, 40-week EMA – except for the January 2018 high that was 13% above, and currently – standing at 9.1% above.
Stairsteps-up and escalator-down… with a return to the long-term mean (or sometimes below it, as occurred at #B), rinse, and repeat…
CURRENTLY…
Currently (at #C, above), the S&P 500 ETF (SPY) hovers at 9.1% above its 40-week EMA – its highest extension above this long-term mean in nearly two years, as seen on the far right of the chart. Also, note that the S&P 500 ETF (SPY) has gained 40.38% since its low on Christmas Eve 2018. Between then and now, we have seen two corrections of the minus-7.3% variety, beginning during the months of May and July 2019. Each of these corrections was bear bait – and opportunities for savvy investors to buy as stock prices neared their 40-week mean.
Question: So if stock prices enter-into another correction from this high, will they stop at the 40-week average – or continue downward as occurred in December 2018?
Answer: TBD at the time – based on macroeconomic conditions and stock fundamentals when the S&P 500 reaches its 40-week EMA.
==> If that situation were occurring today, conditions look favorable for a rebound and more new highs ahead – just as we saw throughout 2019.
Adding More Perspective…
Chart 2 below shows a similar chart to Chart 1 above, extended back to 1970 to provide perspective. However, we had to switch to the S&P 500 index ($SPX) rather than the S&P 500 ETF (SPY), because SPY didn't begin until 1993. In the S&P 500 chart below, we can see that from 1983 to 1998, as the S&P 500 climbed from 100 to 1200 (an 1,100% gain in 15 years), and it repeatedly set new overbought RSI highs at about the same level as today (76).
However, since 1970, outside of those 15 years of relentless climbing during the '80s and '90s – which was the market's most prolonged, most profitable period in history – overbought levels this high were scarce, and always preceded sharp corrections (or worse). The only previous period Are we seeing the harbinger of an imminent selloff or the beginning of a secular climb that could last 15-20 years?
The S&P 500 Index ($SPX) records don't begin until 1925, and that data is rather suspect because tracking was based on on pieced-together components of another index until about 1930. During those five years in the late 1920s, as the S&P 500 accelerated sharply higher in parabolic fashion, the weekly RSI was hitting 100 for months at a time. However, as mentioned, the data is suspect from those early years.
Chart 2: A weekly chart of the S&P 500 Index from 1970, with weekly
RSI shown in the lower window. Is an epic bull market beginning – or a selloff harbinger?
Summary of Market for the Week Ending Friday, December 27
As shown by the list below, all of the major market indices were up last Friday over the prior week's close.
Index Performance – One Week – from Close on Friday, Dec. 20 to Close, Friday, Dec. 27
Chart 3 below shows the performance of five primary equity indices for the last week.
Chart 3: The five primary market indices are shown, ranked by their one-week performance: QQQ, DIA, SPY, IWR, and IWM.
We can see that technology-related and large-cap stocks continue to dominate the performance comparisons for the last week – maintaining the status quo that's been in place over the previous three years – since the beginning of 2017. Small-cap stocks, represented by the Russell 2000 (IWM), bringing up the rear again. This configuration is the classic sign of a mature market, with powerhouse, well-funded behemoths dominating and economically sensitive small-cap stocks lagging. This relationship is reversed at the beginning of a bull market, and small companies dominate the performance charts.
Last week, the NASDAQ (QQQ), Dow (DIA), S&P 500 (SPY), and Russell Mid-Cap (IWR) indices each set new All-Time Highs (ATH) for yet another consecutive week. The only no-show to the ATH party (again) this week remains the Russell 2000 small-cap index (IWM), which remains -2.48% lower than its August 2018 all-time high (ATH) at 170.07.
Index Comparison – One Year – Friday, Dec. 28, 2018 to Friday, Dec. 27, 2019
Chart 4 below shows the performance of five primary indices for the last week. The Invesco Nasdaq 100 ETF (QQQ, blue) is heavily weighted with large-capitalization technology stocks, including well-known names such as Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Facebook (FB), Alphabet/Google (GOOG) and many more, leads the performance comparison with a 40.72% gain for the year, followed by the S&P 500 Large-Cap Index (SPY, 32.61%, black), the Russell Mid-Cap Index (IWR, 31.36%, green), Russell 2000 Small-Cap Index (IWM, 26.88%, purple), and the Dow Industrial Average (DIA, 26.62%, red).
Chart 4: The primary stock indices, represented here by their ETFs, consist of SPY, QQQ, DIA, IWR, and IWM. The Nasdaq 100 (QQQ) returned 40.72% for 2019.
Chart 5 below shows the same presentation of the one-year performance for the five primary stock-market indices in text format:
Chart 5: The five primary stock indices, showing Friday's closing price, the one-week point change, and one-week percentage change.
Sector Performance (Absolute) – One Week – from Friday, Dec. 20 to Friday, Dec. 27
Best Performing Sector: Consumer Discretionary (XLY) at +1.20%
Worst Performing Sector: Utilities (XLU) at -0.33%
Chart 6 below shows Absolute Sector Performance for the week of December 20-27 for the 11 SPDR ETFs that make up the S&P 500 Index (SPY). We can see from this chart that nine of the 11 sectors moved higher for the week, with the Consumer Discretionary Sector (XLY) as the top performer – appreciating 1.20%, followed by the Technology Sector at 1.06%, and the Industrial Sector in a distant third at 0.56%.
Utilities were the weakest group of stocks last week, with a loss of -0.33%, followed by the Health Care Sector with a gain of 0.23%.
Chart 6: S&P 500 Sector performance for December 20-27 features the Utility Sector (XLU) losing -0.33% and Discretionary (XLY) performing best at +1.20%.
Sector Performance (Relative) – One Week - Compared to the S&P 500
Chart 7 below shows the Relative Sector Performance for the week of December 20-27 for the 11 SPDR ETFs that comprise the S&P 500 ETF (SPY). Compared to the absolute performance reported in Chart 4 above, this chart shows the contribution that each sector made to the performance of the SPDR S&P 500 ETF (SPY) over the last week, gaining 1.2%.
The two best performing sectors, i.e – the Consumer Discretionary Sector (XLY) and the Technology Sector, were the only two sectors that contributed to the upside for the S&P 500 ETF's (SPY) return. The other nine sectors presented slight headwinds, with the Utilities Sector being the biggest drag for the week, scoring a relative decline of -0.91% (absolute decline of -0.33%).
Chart 7: S&P 500 Relative Sector performance (compared to the S&P 500) for the last week.
Don't Try to 'Improve' on Your Strategy's Decisions!
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. Over time, this practice will guarantee that your results will return to the average for all discretionary investors – about 2.6% per year – compared to the 30% average return since inception for our models and 77% average AR in 2019 for our top strategies.
Collectively, the ETFOptimize quantitative investment strategies have produced 77 of 77 consecutive winning years since inception. So, please stay with your model's recommendations, and we'll all make it through the Roaring '20s intact!
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