My Current View Of The S&P 500 Index: September 2018

About: iShares Core Total U.S. Bond Market ETF (AGG), EFA, IWM, SPY
by: Walter Zelezniak Jr

Both of my investment objectives were realized in August.

The bull market continues.

Will EFA reverse soon?

Three of the four markets I follow were positive in August and those positive gains translated into a nice return in my retirement account. The market, as measured by the S&P 500 index, closed 3.03% higher in August. As for my pension plan assets, I had a positive return in August as mentioned above and consequently my first investment objective, preservation of capital, was achieved with a 3.20% return on my assets. My second investment objective, beating the S&P 500 index as measured by the ETF SPY, was also achieved. My return bested the SPY by 0.01%. Table 1 below shows my returns and allocations for the month of August and Table 2 below shows my returns for the past 12 months.

Table 1 – Investment Returns for August

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 U.S. Aggregate Bond ETF (AGG), SPDR S&P 500 ETF (SPY), 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 SP 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

Investors in SPY received a gain of 3.19% in August. SPY has now rallied for five months and remains in bullish alignment. SPY closed at a new all-time high. SPY continues to be the best performing ETF that I follow for my retirement account.

Chart 3 – Monthly IWM with 6/10 Moving Averages

Chart 3 shows IWM which had the best monthly gain of the ETFs I follow. IWM gained 4.31% closing at a new all-time high and IWM remains in bullish alignment.

Chart 4 – Monthly IWM:SPY Relative Strength

Chart 4 shows the relative strength of IWM compared to SPY. In August, IWM outperformed SPY by 1.08%. The IWM:SPY ratio in May bullishly broke out of the downward sloping channel outlined in blue and has successfully tested the rising 6 month moving average. If the ratio rises above the previous high set in late 2017, then maybe IWM will have reversed its long term downtrend and enter a period of sustained outperformance over SPY. Only time will tell. In the meantime I will keep my allocation to IWM at 25%.

Chart 5 – Monthly EFA with 6/10 Moving Averages

As Chart 5 shows EFA posted a loss of over 2%. In August, EFA closed below the 10 month moving average for the second time in the last three months. EFA remains in bullish alignment but this alignment may be in jeopardy. Since the all-time high in January, EFA has been in a declining wedge pattern as outlined by the green lines. The declining wedge pattern is considered a bullish reversal pattern but only time will tell.

Chart 6 – Monthly EFA:SPY Relative Strength

Chart 6 shows that EFA underperformed SPY substantially in August. The ratio continues to decline and still remains outside of the green consolidation box. Eventually, this ratio will reverse for a long duration move in which EFA outperforms SPY. A first sign of that would be for the ratio to climb back into the green box. Until I see that reflected in Chart 6 I will maintain my current allocation of 5% to EFA.

Chart 7 – Monthly EFA:IWM Relative Strength

Chart 7 shows that EFA underperformed IWM by over 6% for the month of August. The green box in Chart 7 shows the trading range that the EFA:IWM ratio has been in. For June the ratio dropped below the bottom of the box and in August the ratio remained below the consolidation box. I will be watching this ratio. Similar to the analysis of Chart 6 above, for EFA to outperform IWM for the long term the ratio must first close inside the consolidation box and then continue to move higher. I will continue to monitor this ratio.

Chart 8 – Monthly AGG with 6/10 Moving Averages

Chart 8 shows that AGG registered a gain of 0.57% in August. AGG remains inside the green consolidation box that it has been in for over two years. This consolidation works against trend traders like myself as many whipsaws happen. I will not be allocating any money to this ETF.

Chart 9 – Monthly AGG:SPY Relative Strength

Chart 9 shows that AGG again underperformed SPY and has reached a new low. Chart 9 shows that equities have outperformed bonds for a period of several years. Those are the years that AGG has been inside the green consolidation box described in Chart 8 above. The negative relative strength shown in Chart 9 will keep me out of AGG in September.

For the month of September I will maintain my allocation of 70% SPY, 25% IWM, and 5% EFA. I am confident that my investment strategy has me in good position to take advantage of the current bull market that I expect to continue. Remember that following the moving average crossover system is designed to keep me trading with the major trend. I simply need to read the charts to determine what the consensus is of all market participants and then invest accordingly.

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.