Note: This content should never be used to determine your positions or market exposure. 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.

Do NOT SHARE this content. It is for PAID Premium Strategy Subscribers and Professional Clients ONLY. Sharing this content is a copyright violation. Copyright © 2022, Optimized Investments, Inc., dba ETFOptimize.com. Contact us for permission to reprint selected portions.

Market Message

As predicted last week, Russia invaded Ukraine on Monday, first taking over areas led by Russian separatists in the East, then expanding into the Ukrainian interior – a fact all over the news since it began. This invasion is part of Russia's creeping Imperialism, moving ever deeper toward central Europe at a slow, deliberate pace, each invasion separated by years.

The last incursion was Russia's 2014 takeover of Crimea, which has spawned fighting in the East of Ukraine for the last eight years. Now, Russia is invading the entire country of Ukraine, based on specious reasoning, with the possibility of tens of thousands of deaths and profound human suffering playing out in full color on hundreds of billions of screens across the world.

Will Putin's aggressions tank the US market? Continue reading this article to learn the likely outcome for US stocks and Bonds..

Investors should keep in mind that any response by US equities this week is likely to be temporary. In the long run, profits drive the value of equities. If you think about it, you'll realize that the total elimination of Russia off the economic map would change little – if anything – for publicly traded American corporations.

Most world political events are only temporary blips for equities, but this blip is probably less impactful than most others. The US uses very few products made in Russia. The country has been characterized as a nuclear-armed gas station. To my knowledge, there are no parts in our cars, stereos, computers, or anything else sourced from Russia – a country with a GDP that is less than half the GDP of California alone.

This analysis assumes there won’t be an unthinkable nuclear war. If someone pushes the red button, all bets are off, and the stock market will be the least of our concerns. However, for this analysis, we'll assume that cooler heads will always prevail, and the dystopian contingency of nuclear war is off the table.

There will likely be a further invasion – perhaps much further into Ukraine's interior – in the coming days and weeks. However, Russia doesn't want to prompt a shooting war, because that situation can easily spin out of control. Putin surely realizes that the end-game gets blurry when bullets and missles begin flying.

Investors should keep in mind that any response by US equities this week is likely to be temporary. In the long run, profits drive the value of equities. If you think about it, you'll realize that the total elimination of Russia off the economic map would change little – if anything – for publicly traded American corporations.

Most world political events are only temporary blips for equities, but this blip is probably less impactful than most others. The US uses very few products made in Russia. The country has been characterized as a nuclear-armed gas station. To my knowledge, there are no parts in our cars, stereos, computers, or anything else sourced from Russia – a country with a GDP that is less than half the GDP of California alone.

This analysis assumes there won’t be an unthinkable nuclear war. If someone pushes the red button, all bets are off, and the stock market will be the least of our concerns. However, for this analysis, we'll assume that cooler heads will prevail, and the dystopian contingency of nuclear war is off the table.

Examine the Critical Factors for Stocks

Russian President Vladimir Putin seems focused on the last war – some 77 years ago – when a ground invasion from Nazi Germany was a profoundly existential event for Russia. But will a Russian advisor have the gonads to tell President Putin that the world has moved on from the ground war tactics of Nazi Germany in WWII - which concluded (1945) before Putin was born (1952)? Or are these aggressions just a pretext for other motives?

Putin is savvy, and it's unlikely he's taking risks he hasn't anticipated… at least in the short-term. However, the fog of war creates uncertainties for every participant, and virtually anything can happen – including thermonuclear launches if the war expands into Europe.

Chart 1 below highlights countries most involved in the Russia/Ukraine standoff. The most significant country left out is the US, on the opposite side of the globe and strategically protected on all sides by thousands of miles of either ocean (Atlantic and Pacific) or friendly neighbors (Canada and Mexico). Every country in the world would love to have this sort of logistically inpenetrable buffer around it, and Russia is no different.

This chart highlights how Russia sees Ukraine as potentially part a huge buffer zone between it and the West. Russia already has allies in (from North to South) Estonia, Latvia, Lithuania, and Belarus. Taking over Ukraine would complete this buffer zone between Russia and the West, which seems Putin's objective.

 

Chart 1: A map of Eastern Europe shows three of the four players in the Russian incursion into Ukraine. 

 

The US is not even close to this part of the world; hence, Americans may have a hard time understanding a policy by the Biden Administration (or any other administration) that leads to another war, spending of US treasure, and loss of American lives. The United States is on the opposite side of the globe from the potential field of conflict, strategically protected on all four sides by thousands of miles of natural protection that no other country enjoys.

US protection from outside threats comes from both massive oceans (the Atlantic and Pacific Oceans) and friendly neighbors (Canada and Mexico). The Monroe Doctrine puts this protection in writing, establishing that the US will fight tooth and nail for any incursion into these broad boundaries.

Back to the Russia-Ukraine situation, China is Russia's largest trading partner. Recently, each country's leader – Vladimir Putin of Russia and Xi Jinping of China – used a joint press conference to declare they were committed to supporting one another's interests. 

The announcement suggested there will be potentially devastating consequences if the standoff spins out of control and falls into the violence of a shooting war. The US, Russia, and China are the three most-well-armed countries globally, possessing 12,157 nuclear warheads – far more than enough to wipe out human civilization at the push of a button. 

Americans should recognize that Ukraine isn't another Afghanistan. Russia has thousands of nuclear warheads – even more than the US – and Afghanistan had zero.

Improbable: Such a dire outcome is unlikely to occur, especially since President Biden has pledged to counteract a Russian invasion with sanctions only. However, at 72 years of age, Russia's President Putin is disconnected from the human suffering caused by increasing sanctions on the Russian people. Instead, he is likely looking to establish his legacy in the Russian history books as a strong leader.

As a former KGB officer, Putin thinks about security first. He likely wants a legacy in the history books of a strong, influential Russian leader, on par with the Russian czars of old. Securing Ukraine as a Russian satellite makes Russia feel more secure from Western invasion – by creating a larger buffer with the West.

Effect on Our Model's ETFs

Based on the positioning of the ETFs in the ETFOptimize Premium Strategies, a Russian invasion would be very favorable for their prices and our strategy's performance — in the short term. Our models hold 40% in commodity-based ETFs, taking advantage of higher prices for oil, natural gas, agriculture, and industrial metals. They also own 40% in Defensive ETFs (such as BIL and XLU) and a 20% holding in SDS, the 2x-leveraged, inverse S&P 500 ETF.

While our models do not consider geopolitical risks or news events, an attack on Ukraine would likely result in higher prices on energy-related ETFs (Russia is a crucial provider of oil and natural gas to Europe) and other commodities. US President Biden has pledged to shut down Russian exports with sanctions if there is an invasion, including stopping the Nord Stream pipeline from Russia to Europe via the Baltic Sea into Germany. Again, this will likely result in higher prices for many commodities, especially oil and natural gas, which we own in the ETFs IYE, KRBN, and FCG (Energy, Carbon, and Natural Gas, respectively).

Some may support Russia and believe that the country is under increasing threat from a creeping NATO alliance (potentially expanding into Ukraine, which sparked the crisis). Its incursion into Ukraine is Russia's way of securing its borders. Nationalism is sweeping the world, just as it did in the years following the Great Depression. The Russia-Ukraine tension is another example of nationalism playing out in real-time.

ULTIMATE 6-Model Combo Positions

Our ULTIMATE 6-Model Combo Strategy, which combines the uncorrelated positions from all six of our Premium Strategies, holds a 40% weighting in diverse Commodities, a 40% weighting in a cash-proxy ETF (BIL), and a 20% weighting for the 2x-inverse S&P 500 ETF (SDS, in our S&P 500 Bull/Bear Strategy).

An imperialist incursion by Russia into Ukraine would be regrettable for its 44.3 million citizens, so we're not rooting for that outcome. However, such an action could send the ETFs we hold into the stratosphere – at least for the short term. Geopolitical events DO affect stock prices, but only for relatively short period.

The opposite might also be true (i.e., temporary losses) if Russian President Putin continues this very high-stakes game of hyper-brinksmanship for much longer. Our positions may see significant losses if Putin pulls back his troops and goes home or if investors realize it was all just a ruse to get concessions. However, that path looks less and less likely with each passing day.

So why am I telling you this if these events are unlikely to cause an impactful change? To provide you with an accurate perspective and hopefully stop you from making knee-jerk amateur mistakes that over-ride your rules-based model.

And yes, amateur knee-jerk mistakes are regularly made by our professional clients, too. We are all prone to human error unless we are Warren Buffett-style androids – impervious to money's emotional triggers and subconscious influences.

Indicators and Indices Anticipate Future Events

Having been in this business since the early 1980s, I have often noticed that investment markets and our indicators anticipate future events – even if those events are not currently apparent. Successful investing is frequently a matter of having the discipline to patiently wait for events to play out in real-time. This anticipation of the future is one reason our models often make choices that seem counterintuitive.

Time is one of the most remarkable and mysterious aspects of investing, in which the infinitely minute decisions of hundreds of millions of participants over time, when collectively reflected in stock prices, have far more predictive accuracy than the logic of any investment genius.

Markets are intelligent at a level far beyond what any of us can hope to attain – which is why there is such devotion to data-driven, rules-based investing. When considering investments, check your ego at the door and humbly accept the fact that you'll never out-think the collective decisions of tens of millions of participants.

Likewise, all these financial decisions can often be measured by carefully crafted, algorithmic indicators.

Chart 2 below shows the result of several of our indicators anticipating the 2020 Covid Crash, with our S&P 500 Conservative Strategy moving to cash in late February 2020, altogether avoiding the decline that decimated the portfolios of millions of investors.

Chart 2: In late February 2020, our indicators prompted several of our portfolios to exit equities, preventing any loss of capital.

Time is an innately crucial aspect of investment markets, and the concept of time has likely stunned us all at some point in our lives. Who among us hasn’t remarked about an event that has just occurred, “I knew that was going to happen!”

Science tells us that all events may have already happened, and it's a matter of our brains catching up to those events. When interviewed about his 1905 Theory of Relativity, Albert Einstein remarked, “Time is but an illusion, albeit a very persistent one.” Indeed!

Cracking the mystery of time is something for future generations (if ever) to decipher, but the modern stock market has resolved the secret for investment purposes. Time is a profound aspect of investing, with stock, bond, and ETF/Index prices being soothsayers that predict future events long before we realize they are in the picture. These inherent price predictions provide the basis for all our quantitative algorithms.

This counterintuitive dynamic is why it’s FUTILE to make investment decisions based on current news, and it’s yet another reason we tell subscribers and professional clients to avoid emotion-manipulating, drama-oriented news events. Not just some stories – you should avoid it all and reclaim for you and your loved ones the time wasted monitoring market news.

By the time you hear or read a particular tidbit of market or stock-related news, the affected stock or ETF has long ago discounted that information — often weeks ago, which is phenomenal. Science reveals it's actually possible for stock prices to anticipate the future. Simply put: Price is Truth.

Further Decline Ahead for S&P 500?

In light of the above discussion, our indicators are steadily rolling over and predicting a bearish trend for stocks in the coming weeks and months.

Chart 3 below shows the Proshares Ultrashort S&P 500 ETF (SDS), which our S&P 500 Bull/Bear Strategy recently purchased:

 

Chart 3: The Proshares 2x inverse S&P 500 (SDS) is at a critical point, ready to break through a declining trendline to the upside.

 

 

Will a Head and Shoulders Pattern Play Out?

I was recently asked by a subscriber why he should have confidence in our S&P 500 Bull/Bear Strategy's selection of SDS, the Proshares S&P 500 2x-Inverse ETF – and how a 20%+ profit target could play out? Let’s consider the Head-and-Shoulders pattern displayed by the world’s most widely traded index, the S&P 500.

Some technical analysts say that a sharp downturn is ahead because the S&P 500 has formed a classic head and shoulders (H&S) pattern. Our models don't use subjective technical formations in their rules-and-data-based systematic, quantitative assessment. However, these technical patterns often occur as expected because they include clear support and resistance levels reflecting the decisions of millions of investors. It will be interesting to see if this analysis plays out in the coming weeks as pattern-oriented technicians expect.

Chart 4 below shows the S&P 500 ETF (SPY) with a classic Head-and-Shoulders pattern – identifying the Left Shoulder, the Head, and the Right Shoulder. The lows set last October 1 and in late-January form a "neckline" for this pattern. The high last September establishes the Left Shoulder and the high in January (before falling again last week) sets the Right Shoulder at about 450.

 

Chart 4: Technicians say a classic Head-and-Shoulders pattern has formed in the S&P 500 chart. A decline to 380 is appropriate for SPY.

 

Because enough of our indicators switched to "Risk Off" after last week's inflation report sunk the market, the path of least resistance for stock prices in the short term is lower than current levels. While the S&P 500 will undoubtedly run into a few days of indecision at its 430 Support level at the Head-and-Shoulders neckline, that neckline is likely to be broken considering the technical damage already done in January-February, the interest-rate increases expected to begin in about three weeks.

23% Profit Target on SDS

Accompanying our purchase of SDS was a comment that its Profit Target is a gain of 20% to 27%. This amount represents the anticipated decline of the S&P 500 after it has pierced its H&S neckline (shown in Chart 4 above). Technical analysis projects that the length of the arm below the neckline is equal to the distance between the neckline and the top of the head.

The distance from the neckline to the top of the head was about 11.5%, so a decline of another -11.5% from the neckline – to around 380-to-385 for SPY – would be appropriate. From current levels, this decline would represent a gain of about 23% for our 2x-inverse S&P 500 ETF (SDS).

We based this projection upon generally accepted technical theory. Whether or not this outcome occurs, remember that the 2x inverse exposure in SDS is likely to be volatile. 

Selloffs are always volatile, and this one might be even more volatile than typical because equities are returning to a fundamentally based price rather than an artificially based price spurred higher by two years of 0% interest rates and trillions of dollars of Quantitative Easing. The coming decline in equities represents a deflation of this air pocket – i.e., Quantitative Tightening.

We have daily stop-loss thresholds in place, and if any position violates a certain multi-component-driven price level at the market close (not intraday because of too much noise in intraday prices), we will send that model's subscribers an email notice with instructions to sell the ETF the following day.

 

+––––––––––––––––––––––––––––––––––––––––+

General Advice for Quantitative Strategy Users:
Follow Your Strategy's Recommendations – To the Letter!

If you pay attention to financial media, it may sound like the end of the world is upon us (again), and a total collapse of the financial system is nigh. It's always one 'crisis' after another in media-land.

Our staff has been fielding an increasing number of inquiries from concerned clients who can't seem to tear themselves away from their adrenalin-producing, cable-tv addiction, particularly CNBC. They are looking to us to inquire how confident we are to stay invested at this precarious time. (*Answer: We aren't confident at all in past winners, but we're 100% confident in each of our Premium Strategy's ability to select profitable investments as each week develops and those positions grow over longer investment periods. You shouldn't use our model's selections as short-term trades.)

Personally, I follow the savvy advice for quantitative investors to diligently avoid the financial media. I bring this point up primarily to remind readers of our recommendation about the deleterious effects of the cable news (particularly during times like these). These TV and internet-content producers have a financial motivation to elevate and churn your emotions for their own benefit.

Heightened emotions during market meltdowns prompt increased viewership, but those heightened emotions often trigger poor investment decisions, or at the very least, can seep into your subconscious and may affect your investment decisions in ways you don't realize. For more information on how subconscious emotions affects investors, I recommend reading "Thinking Fast and Slow," by Nobel-prize winning Behavioral Economist Daniel Kahneman.

What's the solution to the damaging heuristics and biases that cause 99% of investors to underperform the S&P 500 and attain an average, long-term return of only about 2.6%? Well, considering that financial analysis is a quantitative discipline, perhaps that's a hint. We don't hire engineers or physicians to create quarterly reports on our publicly traded businesses, we hire accounting firms. Systematic, data-driven, quantitative investing is the answer. Your investing decisions should rely on numbers – not on opinions – for your investing success.

Nevertheless, the weak link in our approach is still the investor – i.e., you. If you can stick with them diligently, ETFOptimize offers a set of high-performance, sophisticated quantitative strategies, collectively proven with profitable performance for more than 100 consecutive years. Our Premium Models have never recorded a money-losing year and have an average annual return of about 30% since 2000. The average maximum drawdown is only 11%. Run the numbers on a 30% annual return HERE. At this rate, consistently saving $10,000 per year for 15 years will provide an account large enough upon which to retire for 35-40 years (at a drawdown of $60,000 annually).

However, to attain this result, investors must follow the guidance of their rules-based system 100%, otherwise you eliminate all a systematic strategy's human-error eliminating benefits. For this reason, we regularly remind clients and other subscribers of the importance of following their system to the letter.

Following a mechanical system consistently can sometimes be challenging. You might be surprised by the selections (because they can be contrarian to the generally-accepted wisdom) and sometimes they'll result in short-term losses (trends must be in place a certain amount of time before they can be assessed and determined to be 'trends'). Nevertheless, in the long run, a systematic, rules-based investment approach will outperform virtually every discretionary approach to which it is compared.

Bottom-line: stick with your model’s recommendations!

 

For success with a Rules-Based Investment Strategy, FOLLOW YOUR STRATEGY'S GUIDANCE 100% !! For success, don't SECOND GUESS your Systematic Model! Investor’s emotions and subconscious biases consistently sabotage their investment results. A rules-based, quantitative system will eliminate those problems — BUT – you must follow the strategy's recommendations without second guessing them! Follow the recommendations TO THE LETTER if you wish to succeed. That doesn't mean every trade will be a winner, but the probability of succeeding in reaching your long-term financial goals is far greater with a carefully crafted, rules-based Strategy – as offered by ETFOptimize. The ETFOptimize Premium Strategy lineup doesn't collectively have a record of 92 consecutive years of profitability without a good reason. Rules-based investing works! But it only works for you if you work it precisely!

 

 

NEED ASSISTANCE?

If you have questions about this content, please contact us at your convenience via our Support Ticket system. Usually, we'll respond much sooner, but please allow 24 hours for a Support Team member to respond. We also hope you will take a moment to provide us with feedback on the site content and design, new features, and our product line. Your input is much appreciated!