My Current View Of The S&P 500 Index - January 2018

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Includes: AGG, EFA, IWM, SPY
by: Walter Zelezniak Jr

Summary

The S&P 500 index had a great year in 2017.

EFA was the best-performing ETF in December.

An allocation change is made.

The stock market again closed higher in December. The market, as measured by the S&P 500 index, closed 0.98% higher. The SPDR S&P 500 ETF (SPY) gained 1.21% for the month. As for my pension plan assets, I made money in December. 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 December. Table 1 below shows my return for the month, and Table 2 below shows my returns for the past 12 months.

Table 1 – Investment Returns for December

Table 2 – Investment Returns 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 Total U.S. Bond Market 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.

I employ this strategy because I do not want to experience a large drawdown with my pension assets. 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.

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

SPY was up 1.21% in the month of December. 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 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 posted a small loss in December, closing down 0.40%. Even though there was a loss for the month, IWM remains in bullish alignment, indicating the high probability that IWM moves higher from here.

Chart 4 – Monthly IWM:SPY Relative Strength

Chart 4 shows the relative strength of IWM compared to SPY. Essentially, IWM has underperformed SPY since late 2016. For the month of December, IWM underperformed SPY by 1.59%. Once the IWM:SPY ratio closes above the highs made in December 2016, then IWM may enter a period of sustained outperformance compared to SPY. Until then I will keep my allocation to IWM under 50%.

Chart 5 – Monthly EFA with 6/10 Moving Averages

In December, EFA was the best performing ETF that I track for my pension assets. It closed up 1.35%. EFA remains in a bullish alignment as the 6-month moving average is higher than the 10-month moving average while both moving averages are sloping higher.

Chart 6 – Monthly EFA:SPY Relative Strength

As mentioned above, Chart 6 shows that EFA outperformed SPY by 0.13%. The ratio of EFA to SPY appears to be rolling over as the 6-month moving average and the 10-month moving average are now sloping downward, meaning that the ratio is not in bullish alignment. Similar to Chart 4 above, once the EFA:SPY ratio closes above the highs made earlier this year, then EFA may enter a period of sustained outperformance compared to SPY. Until then, I will keep my allocation to EFA under 50%.

Chart 7 – Monthly EFA:IWM Relative Strength

Chart 7 shows that EFA outperformed IWM in December by 1.75%. If the EFA:IWM ratio closes above the highs made earlier in 2017, then a trend change could be in place indicating sustained outperformance of EFA compared to IWM. If that takes place I would allocate more money to EFA compared to IWM.

Chart 8 – Monthly AGG with 6/10 Moving Averages

Chart 8 shows that AGG investors made money in December as AGG closed 0.48% higher. AGG remains in bullish alignment.

Chart 9 – Monthly AGG:SPY Relative Strength

While Chart 8 shows that AGG is in bullish alignment, Chart 9 shows why I do not have any money allocated to AGG. Simply put, this is an equity bull market and equities have vastly outperformed bonds. AGG continues to underperform SPY, and you can see that the ratio closed at a new low in December.

For the month of December, I was allocated 50% SPY, 30% IWM and 20% EFA. For January, I will change that allocation to 60% SPY, 20% IWM, and 20% EFA. All three of those ETFs are in bullish alignment and the current trends are strong. My thoughts are that my moving average crossover system has me in a good position to take advantage of the current bull market. Last month I also wrote an article that outlined some fundamental factors that make me feel that 2018 may be a bullish year for the market as well. The beauty of my moving average crossover system is that I don’t have to try to predict what will happen. I just observe what has happened and understand that if the ETFs are in a bullish alignment that means there is a high probability of good things happening in the not too distant future. Have a Happy New Year everyone and good luck with your investing.

Disclosure: I am/we are long SPY, EFA, IWM.

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.

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