My View Of The S&P 500 Index - November 2017

Summary

• The bull market continues to move higher.
• My moving average crossover system is long the market.
• Trend following is designed to be easy and profitable.

Another month and another gain in the stock market. This bull market keeps on going higher and higher. The market, as measured by the S&P 500 index, was up again in October and closed 2.22% higher. The SPDR S&P 500 ETF (SPY) gained 2.36% for the month. As for my pension plan assets, I too gained for October. Consequently, my first investment goal, preservation of capital, was achieved. Unfortunately, I did not beat the returns of the S&P 500 index as measured by SPY. So only half of my investment objectives were met for the month of October. Table 1 below shows my returns for the month and Table 2 below shows my returns for the past 12 months.

Table 1 – Investment Returns For October

Table 2 – Investment Returns For Last 12 Months

To review the purpose of this series of articles, my retirement account only allows me to buy the following four ETFs: iShares Core U.S. Aggregate Bond ETF (AGG), SPDR S&P 500 ETF, iShares Russell 2000 ETF (IWM), and iShares MSCI EAFE ETF (EFA). I can also have my money in cash. The question is how to decide where and when to allocate money to these various ETFs.

I use my moving average crossover system combined with relative strength charts to determine how to allocate my pension plan assets. My moving average crossover system uses the 6-month and the 10-month exponential moving averages to identify which of the four ETFs are in a position to be bought. If the 6-month moving average is above the 10-month moving average, then the ETF is a buy. I call this setup being in bullish alignment. When the 6-month moving average is below the 10-month moving average, the setup is referred to as a bearish alignment. When a bearish alignment happens I don’t want to hold that asset. See Chart 1 below for a long-term look at the S&P 500 index using my moving average crossover system.

Chart 1 – Monthly S&P 500 Index with 6/10 Moving Averages

You can see that the moving average crossover system provided some excellent long-term buy and sell signals that would have allowed investors to capture long duration moves in the index, while avoiding costly drawdowns. Avoiding these costly drawdowns allows me to meet the objective of capital preservation.

To me, the last place you want to experience a large drawdown is in your pension plan. During the 2008-2009 market crash, many people didn't even look at their retirement statements because they were afraid of what they would find. I submit that if those people would have used a market strategy similar to what I outline in this series of articles, they would have been able to avoid much of the decline during the bear market and consequently would have had less emotional stress during that time period.

I find this investment strategy to be particularly useful for managing the assets in my pension plan. If your pension plan is anything like mine, then you just have a choice of ETFs or mutual funds to select from. Looking at standard fundamental criteria such as P/E ratios, free cash flow, dividend yield, and the like is not easily applied to stock indices and mutual funds. What is easily applied to stock indices and mutual funds is trend following technical analysis as I show in this article.

The following charts show the current status of the ETFs that I am allowed to buy in my retirement account.

Chart 2 – Monthly SPY with 6/10 Moving Averages

As mentioned in the opening paragraph, SPY was up for the month of October gaining 2.36%. Looking at Chart 2, you can see the strong uptrend that is in place since the last buy signal was given. The trend has been easy to follow since the buy signal occurred when the 6-month moving average crossed above the 10-month moving average and that is the idea. Trend following is meant to be easy and profitable.

Chart 3 – Monthly IWM with 6/10 Moving Averages

Chart 3 shows that IWM gained 0.73% for the month and closed at a new high. In last month’s article, I said I would allocate some money to IWM and that is what I did. Since the buy signal was generated in August of 2016 IWM has gained over 24%.

Chart 4 – Monthly IWM:SPY Relative Strength

Chart 4 shows the relative strength of IWM compared to SPY. When the signal line is trending higher it means IWM is outperforming SPY. When the signal line is trending lower it means the opposite; IWM is underperforming SPY. The downward sloping trend line from early 2014 to early 2016 shows that investors would have made more money investing in SPY versus investing in IWM.

For October, IWM underperformed SPY by 1.59%, giving back some of the outperformance IWM had in the month of September. If the ratio can take out the highs of last December, then the downtrend in the ratio that was discussed in a previous article will have reversed. The ratio is still above its recent low in June. I will continue to maintain a small position in IWM and monitor this ratio.

Chart 5 – Monthly EFA with 6/10 Moving Averages

EFA had another good month and closed up 1.68%. EFA closed at a new high again in October and EFA remains in bullish alignment. The trend is growing stronger as the distance or the whitespace between the 6-month moving average and the 10-month moving average is getting wider.

Chart 6 – Monthly EFA:SPY Relative Strength

Chart 6 shows that EFA, like IWM mentioned previously, was outperformed by SPY. Despite the underperformance, the ratio remains in bullish alignment. The relative strength ratio in Chart 6 is one to watch closely. Since 2013, US stocks have outperformed international stocks until early 2017. Readers can see this as the signal line falls in Chart 6 from the upper left corner to the lower right corner. However, I see that a change is taking place as the signal line is now starting to trend higher since early 2017, and the 6-and 10-month moving averages have gone into bullish alignment.

Chart 7 – Monthly EFA:IWM Relative Strength

As I mentioned last month, the EFA:IWM ratio could be rolling over. EFA did outperform IWM so the ratio closed higher. Two months ago the 6- and 10-month moving averages moved into a bullish alignment and they remain in bullish alignment, but both moving averages are sloping downward. I will continue to monitor this ratio.

Chart 8 – Monthly AGG with 6/10 Moving Averages

AGG had a minimal gain and remains in bullish alignment. Bonds investors are still making money but investors in bonds are lagging the returns of investors in equities as can be seen in Chart 9.

Chart 9 – Monthly AGG:SPY Relative Strength

AGG continues to be outperformed by SPY and the ratio closed at a new low in October. Investors simply prefer stocks over bonds at this time. This simple ratio confirms that equities continue to be the place to put your money. None of my retirement assets are allocated to AGG.

For the month of October, I was allocated 50% EFA, 25% IWM and 25% SPY, and I will maintain that allocation for the seasonally strong month of November. The ETFs for EFA, IWM, and SPY are in bullish alignment and the current trends are strong as depicted in Charts 5, 3, and 2, respectively. I have used the relative strength charts to allot my assets and I favor the indication in Chart 6, so I have 50% of my allotment to EFA as I expect it to outperform SPY in the near future. All in all, I think that my moving average crossover system has me properly aligned and I will continue to monitor the charts.

Analyst’s Disclosure: I am/we are long EFA, IWM, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.