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

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

Small caps contributed to a slight loss in September.

EFA is in a bullish continuation pattern.

The bullish month of October is upon us.

In September, two of the four markets I follow were positive. The market, as measured by the S&P 500 index, closed 0.43% higher in the month. As for my pension plan assets, I had a negative return in September. Consequently, my first investment objective - preservation of capital - was not achieved. My second investment objective - beating the S&P 500 index as measured by the ETF SPY - was also not achieved. My return lagged the SPY by 0.71%. Table 1 below shows my returns and allocations for the month of September, and Table 2 below shows my returns for the past 12 months.

Table 1 - Investment Returns for September

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 Trust 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 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 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

The bull market continued in SPY as that ETF gained gain 0.59% in September - a month that is often dangerous for equity investors. It has now rallied for six months and remains in bullish alignment. The fund 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 largest loss in September of all the ETFs I follow. The -2.32% return, combined with my 25% allocation, was the reason I lost money in September. IWM remains in bullish alignment. The only positive note is that the negative return did come on the lowest volume of the year. This indicates that the selling is nothing to be too concerned about.

Chart 4 - Monthly IWM:SPY Relative Strength

Chart 4 shows the relative strength of IWM compared to SPY. In September, IWM underperformed SPY by 2.09%. In May, the IWM:SPY ratio bullishly broke out of the downward sloping channel outlined in blue, and it has successfully stayed above that channel. I am still waiting to see if the ratio rises above the previous high set in late 2017. If that happens, then maybe IWM will reverse 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 gained 0.97%, which was the largest gain of the ETFs I follow for the month of September. The green lines show the price action for EFA in 2018. The price action looks to me like a bullish flag or a declining wedge chart pattern. Both of those patterns are considered bullish continuation patterns and should result in the fund moving higher rather than moving lower. It remains in bullish alignment. I will continue to monitor EFA.

Chart 6 - Monthly EFA:SPY Relative Strength

Chart 6 shows that EFA outperformed SPY in September by 0.37%. The ratio 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 the fund.

Chart 7 - Monthly EFA:IWM Relative Strength

Chart 7 shows that EFA vastly outperformed IWM by over 3% for the month of September. 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 September, it 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 loss of 0.62% in September. It has flattened out over the past six months and 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 allocate any money to this ETF in October.

Chart 9 - Monthly AGG:SPY Relative Strength

Chart 9 shows that AGG again underperformed SPY and has reached a new low. It 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 the fund in October.

For the month of October, I will maintain my allocation of 70% SPY, 25% IWM, and 5% EFA. October is the start of the bullish equity season that runs from October to May. I am confident that my investment strategy has me in good position to take advantage of the current bull market which 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, IWM, EFA.

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.