In October, for the first time since I have been writing this series of articles, all four of the markets I follow were negative. The market, as measured by the S&P 500 index, closed 9.94% lower in October. As for my pension plan assets, I had a negative return in October. 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 1.08%. Table 1 below shows my returns and allocations for the month of October and Table 2 below shows my returns for the past 12 months.
Table 1 – Investment Returns for October
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
The bull market in SPY was challenged as that ETF lost 6.91% in October. SPY is still positive for the year and remains in bullish alignment as the 6 month moving average is almost 5 points higher than the 10 month moving average. We are now in the seasonally bullish period so I have confidence we will see higher highs ahead. In the meantime I will be keeping my eyes open for a moving average crossover indicating that the market has turned bearish.
Chart 3 – Monthly IWM with 6/10 Moving Averages
Chart 3 shows IWM which had the largest loss in October of all the ETFs I follow. If you recall it also had the largest loss in September as well. The -10.99% return, combined with my 25% allocation, was the reason I underperformed SPY in October. Like SPY, IWM remains in bullish alignment. However, the gains for the year have been wiped out. IWM is now negative for the year.
Chart 4 – Monthly IWM:SPY Relative Strength
Chart 4 shows the relative strength of IWM compared to SPY. In October, IWM underperformed SPY by 4.38%. The ratio also closed back inside the downward sloping channel outlined by the two blue lines. Due to the ratio falling back inside the downward sloping channel I will change my allocation of IWM to 15%.
Chart 5 – Monthly EFA with 6/10 Moving Averages
Chart 5 shows that EFA lost 8.13% in October. It also shows a moving average crossover. The 6 month moving average is now less than the 10 month moving average. As I mentioned last month I can find some bullish signals for EFA. While EFA did break below its bullish flag or declining wedge pattern it did not close below the green support line that goes back to 2014. That piece of news could be considered bullish. However, my trading signals are derived from the moving averages and not from the chart patterns. Consequently, I will not allocate any money to EFA until it goes into bullish alignment. I will continue to monitor EFA.
Chart 6 – Monthly EFA:SPY Relative Strength
Chart 6 shows that EFA underperformed SPY in October by 1.31%. 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. I will continue to monitor this ratio.
Chart 7 – Monthly EFA:IWM Relative Strength
Chart 7 shows that EFA vastly outperformed IWM by over 3% for the month of October. This is similar to what happened in September. The green box in Chart 7 shows the trading range that the EFA:IWM ratio has been in. In June the ratio dropped below the bottom of the box and in October the ratio remained just 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 0.64% in October and now is in bearish alignment. AGG 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 November.
Chart 9 – Monthly AGG:SPY Relative Strength
Chart 9 shows that AGG solidly outperformed SPY in October by 6.73%. Taking a longer term view of 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 November.
For the month of November I will change my allocation to 85% SPY, 15% IWM, and 0% EFA. November is historically a bullish month. 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, 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.