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.

 

Historic Selloff Followed by Historic Rally

In late February, there was a widespread, simultaneous recognition by investors that the COVID-19 (aka, 'the coronavirus') pandemic that was sweeping the world and would have a significant, negative economic impact. US stocks subsequently sold off at a pace that has set historic records. This weekend, investors find themselves a little over one month out from the beginning of that selloff – and we can make a few assessments from this distance.

An all-time daily closing high (ATH) in the S&P 500 (SPY) was set on February 19 at 336.36, and the closing low of the selloff (to-date) occurred on March 23 at 222.95 – a decline of -33.72%. Since that near-term low, the S&P 500 then surged about 17% over three days from Tuesday to Thursday (March 24-26) last week. However, investors should not chase this short-term rally, as it only amounts to an oversold bounce – one that is likely to lure many speculative novices to more financial losses, in a market that may already be heading lower.

Chart 1 below displays the S&P 500 ETF (SPY) for the last six months, with a -34% decline from February 19 to March 23, followed by a three-day gain last week of 17%.

 

Chart 1: The SPDR S&P 500 ETF (SPY) declined 34% from its all-time high (ATH), followed by a 17% bounce last week. Expect more downside ahead.

ETFOptimize called the market top on February 20, 2020, in a report published for our subscribers – "Too Far, Too Fast – 2020" – in which we documented many of the indicators that were providing cautionary signals for our quantitative ETF strategies; already switching them to defensive positions. We expect the decline to continue (more below)…

Chart 2 below shows that the recent decline is tied with the 1987 selloff for the largest one-month (20-period) selloff in the history of the stock market (represented by the S&P 500 index), beating out a similar period during the depths of the Great Depression. In each of these crashes and most other similar situations, prices had moved up far too quickly, and stocks were ripe for a fall.

 

Chart 2: A recent 20-period span produced a Rate-of-Change (ROC) of -29.56% – the largest decline in history, beating out the Great Depression and the 1987 selloff.

 

During the 20-trading-period span that ended on March 20, 2020, the S&P 500 index had a rate-of-change (ROC) of -29.56% – which is identical to the fast-paced 1987 crash. Third place goes to the 20-period span ending September 29, 1931 – when buy-and-hold investors sustained a one-month loss of -28.92% during the Great Depression.

Chart 3 below shows that the 10-week Standard Deviation of the S&P 500 index reached an all-time high last week of nearly 360. This figure dwarfs all other measures of the 10-week standard deviation of the market since the S&P 500's formation in 1925.

 

Chart 3: The S&P 500's 10-week Standard Deviation hit an unprecedentedly high level in the recent selloff, dwarfing all other prior market crashes.

Following the -34% S&P 500 selloff from the February 19 high, last week we witnessed a robust 17% rally on Tuesday, Wednesday, and Thursday (March 24-26) that retraced a significant amount of the decline. However, all indications are that this is a typical oversold, counter-trend rally, which already appeared to begin failing on Friday. Many investors who are not following a systematic investment strategy were lured back into the market by chasing this three-day run – and are likely to only to lose that money once again in the coming weeks.

Why Some Models Are Holding Cash-Proxy ETFs

The ETFOptimize models began holding defensive positions before the downtrend started. Most of of our models then switched to cash-proxy ETFs on March 16 – triggered by the Fed's emergency lowering of the overnight rate to 0%  – and will remain in those positions until each model's quantitative indicators specify that long positions are once again appropriate (partially determined by each model's targeted level of risk/return).

Crucial Point: Subscribers shouldn't get caught up in deciding what 'should' happen across various asset classes and overriding their model's recommendations during the current bear market. Far more important is what IS happening – because very strange things happen during market crashes.

Intermarket relationships DO work – in the long run – and are a key driver of the ETFOptimize systematic model's successes. However, as we saw several times in the past month, these relationships can often break down when circumstances get dire, and investor confidence plummets. During bear markets – such as the one we are now in – all asset classes can decline or rise simultaneously, and that's precisely what we saw over the last month. These hedges have broken down, and the only safe and logical position is cash-proxy ETFs. Investors who have some money in the ETFOptimize strategies and are using discretionary approaches for the remainder should be careful to avoid any aggressive moves. Those emotion-based decisions are likely to culminate in quick and painful losses.

Chart 4 below shows three asset classes, the S&P 500 ETF (SPY), 20-Year Treasury ETF (TLT), and SPDR Gold Shares (GLD) for the last month. Conventional wisdom says that when the S&P 500 stocks (SPY) are declining, defensive assets such as Treasuries (TLT) and Gold (GLD) should be rising. However, we saw all three of these asset classes falling simultaneously in the past month, with peak-to-trough declines of -28.4% (SPY), -15.7% (TLT), -12.4% (GLD), respectively, as investors went into panic mode, selling assets across the board. Then, beginning on different days, these asset classes all began rising in unison, which is quite unusual.

 

Chart 4: Conventional intermarket relationships have broken down as all assets get sold in a bear market.

 

Each week, the ETFOptimize quantitative investment strategies automatically examine the internal price direction and volatility of all major asset classes, making a relative comparison that determines the appropriate exposure to the market – and alternative asset classes (if applicable).

High internal price volatility within specific structures across asset classes and bonds – as we have seen recently – can signal our investment strategies to make a rare move to cash-proxy ETFs, such as the iShares 1-3 Year Treasury Bond ETF (SHY), the Goldman Sachs 0-1 Year Treasury Bond ETF (GBIL), or the iShares Short-Term Treasury ETF (SHV) – i.e., risk-off, directionless ETFs that are currently being held in many of our models.

Some people may reason that, "Why do I need a subscription investment model if you are only holding cash?" The answer is because each week, our models examine carefully crafted composites of as many as 38 different data sets, and will determine the appropriate time to reenter the market with aggressive positions (in some cases 2x-leveraged ETFs) that will provide incredible performance to reward that excellent timing. For example, in the last three-quarters of 2009, our most popular strategy produced a return of more than 1,600%.

An example of how well our strategies perform in the face of market downturns can be shown by our least-aggressive model, the S&P 500 Conservative Strategy, which continues to head higher even as the market sold off by -34% in the last month.

 

Performance Chart

(July 1, 2006 - Present)

KEY: The red line shows the 'S&P 500 Conservative Strategy's' performance since inception. 
The blue line shown as the benchmark is a buy-and-hold of the SPDR S&P 500 (large-cap) ETF (SPY). the

 

 

Why a Continuation Downward?

Last week, the Federal government took unprecedented steps to shore up the US economy, with a $2 trillion coronavirus stimulus package that provides a direct supplemental income check of $1,200 for all earners under $75k, bailouts for airlines and other hard-hit industries, loans to small-and-medium-sized businesses, and extra unemployment-check supplemental payments for those laid off in recent pandemic-related business closures. Also, on March 15, the US Federal Reserve lowered the overnight lending rate to between 0.0% and 0.25% and is purchasing assets once again in a new round of quantitative easing.

Many investors, believing that these efforts would mark the end of the economic downturn, began to believe that many stocks that have seen their prices return to levels last seen in February 2017 are now incredible bargains. For example, according to advisor Jeffries, you can be "practically stealing" quality stocks now – but be aware this advice may serve the needs of the advisor before serving the needs of the investor/client.

The idea that current conditions present a buying opportunity is nonsense – unless you have a many-year time horizon for recovery and gains from the continuing downturn. What we saw last week was nothing more than a three-day, oversold bounce of prices. While stocks could continue a bit higher before plummeting back downward again, more negative news in the coming weeks is likely to have a continuing dilatory effect on prices.

With the US surging into the lead of coronavirus cases in nations across the world, accompanied by more than 2,000 deaths (doubling every two days or so), we can expect the negative headlines to pile up fast and deep. In the next few weeks, experts say we will see hospitals simultaneously overrun by demand, with spontaneous decisions needing to be made by healthcare professionals about which patients live and which shall die miserably on cots in the hospital's halls. We should all do what we can to support the doctors, nurses, and other healthcare workers in our communities – and pull together to help out those in need if it is safe to do so.

We are likely only at the beginning of this crisis – a medical event with unprecedented economic implications and the probability of enormous unintended consequences from impromptu decisions. The US and the rest of the world addressed the 2008 credit crisis by taking on even more profound levels of debt, with many corporations using low-interest loans for stock buybacks that would increase share prices for insiders and shareholders. There may soon be nothing to show for all of the debt incurred to boost share prices if those prices soon fall back to where they started a decade ago (more about this target for the market bottom in our next article).

 

Bearish Indicators

Why are we so sure that we are not seeing a V-shaped bottom right now? We will publish another report in the next few days documenting many of our indicators, their bearish status, and the likely level where the market will bottom, but here are two of the critical indicators that are signaling there is further downside ahead:

 

VIX REMAINS ELEVATED ABOVE 60

Even as the S&P 500 recovered one-third of its losses in the last week, the CBOE Volatility Index ($VIX) remained elevated above 60. This means that options investors are hedging a vast amount of money against future market losses.

 

Chart 5: The CBOE Volatility Index ($VIX) remains elevated above 60 even as the S&P 500 rose by 17% last week.

 

VIX FUTURES ARE IN BACKWARDATION

Moreover, VIX futures contracts are showing backwardation – a set up that is the opposite of the typical trend and very bearish. Today, near-term contracts (April 2020 at $53.40) are priced much higher than longer-term contracts (December 2020 at $29.25) – a status that is the exact opposite of normal conditions.

 

Chart 6: Backwardation in the VIX Futures market is a bearish indicator.

 

 

Market Conditions for the Week Ending Friday, March 27

As shown by the list below, all of the major market indices were significantly higher on Friday over the prior week's close.

One-Week Index Performance – Close on Friday, March 20 to Close, Friday, March 27

Chart 3 below shows the performance of five primary equity indices for the last week.

 

One-Year Change

Chart 7: The five primary market indices are shown, ranked by their one-week performance: DIA, SPY, IWR, DIA, IWM, SPY, and QQQ.

 

One unusual development in the last week is that technology-related stocks in the NASDAQ 100 (QQQ) underperformed other major market indices with a gain of only 8.8% over the prior Friday's close. This is unusual because QQQ has been outperforming all other sections of the market by a significant amount for quite some time.

The NASDAQ 100 (QQQ) was – by far – the best-performing section of the market during the rally leading up to the crash (41% vs. 33% for SPY during 2019), declined less than other indices during the crash (-27% vs. -33% for SPY) and rallied stronger last week than other indices. The top-performing section of the market was the Russell MidCap ETF (IWR), which gained 13.71% last week – a 55% outperformance of the NASDAQ 100 (QQQ).

 

Index Comparison – One Year – Friday, March 27, 2019 to Friday, March 27, 2020

Chart 8 below shows the performance of five primary indices for the last year. The Invesco Nasdaq 100 ETF (QQQ, red) is the only index that has a positive return for the previous year. QQQ, which 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 4.03% gain for the year, followed by the S&P 500 Large-Cap Index (SPY, -8.45%, black), the Dow Industrial Average (DIA, -14.56%, blue), the Russell Mid-Cap Index (IWR, -18.75%, purple), and the Russell 2000 Small-Cap Index (IWM, -25.40%, green).

 

One-Year Change

Chart 8: The primary stock indices, represented here by their ETFs, consist of SPY, QQQ, DIA, IWR, and IWM. The Nasdaq 100 (QQQ) returned 4.03% for the last year.

 

 

Chart 9 below shows the same presentation of the one-year performance for the five primary stock-market indices in table format:

 

One-Year Change

Chart 9: 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:  Utilities (XLU) at  +17.60%
Worst Performing Sector:  Communications (XLC) at +6.61%

Chart 6 below shows Absolute Sector Performance for the week of March 20-27 for the 11 SPDR ETFs that make up the S&P 500 Index (SPY). We can see from this chart that all of the 11 sectors moved higher for the week, with th defensive Utilities Sector (XLU) as the top performer – appreciating 17.60%, followed by the Real Estate (XLRE) Sector at 15.77%, and the Industrial Sector (XLI) was third highest at 15.46%.

Communications (XLC) companies were the weakest group of stocks last week, with a gain of 6.61%, followed by the Consumer Staples Sector with a gain of 6.78%.

 

Chart 10: S&P 500 Sector performance for March 20-27 features the Utility Sector (XLU) leading with 17.6% and Communications (XLC) performing worst at +6.61%.

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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