My Current View Of The S&P 500 Index: January 2019

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

2018 proved to be a tough year in my retirement account.

Bonds performed well in December.

Allocation changes for January.

Well, 2018 is over, and it was not a great year for my retirement account. The price action in December did not help as all of the equity positions I follow were negative for the month. The market, as measured by the S&P 500 index, lost 9.18% in December. As for my pension plan assets, I had a negative 9.28% return in December. 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 0.48% in December. Table 1 below shows my returns and allocations for the month of December, 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

In 2018, I underperformed SPY by almost 3%. In other words, I lost almost 3% more than the SPY did in 2018. As I mention further below in the article, poor use of one of the ratio charts shown below contributed to this underperformance in 2018.

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

Chart 2 shows that SPY lost 8.80% in December. It remains in bullish alignment by the barest of margins. Chart 2 actually provides an interesting problem. Chart 1 above shows that $SPX is now in bearish alignment. Its 6-month moving average is below the 10-month moving average. However, the ETF proxy for $SPX, which is SPY, is not quite in bearish alignment. In this case, I will yield to the $SPX chart and consider SPY in bearish alignment, therefore moving my money out of SPY in my retirement account.

Chart 3 – Monthly IWM with 6/10 Moving Averages

Last month, I wrote that IWM stabilized in November. Well, Chart 3 shows that IWM wasn’t very stable in December as IWM lost a whopping 11.97%. If you recall, IWM lost 11% in October as well. I don’t know what will happen in the future, but IWM is now in a bearish alignment, so I will not allocate any of my retirement assets to IWM in January.

Chart 4 – Monthly IWM:SPY Relative Strength

Chart 4 shows the relative strength of IWM compared to SPY. In December, IWM underperformed SPY by 3.47%. If there is one thing I wish I did better in 2018, it would have been utilizing this ratio chart better. For example, the ratio failed to make a higher high in May. It then declined in July. At that time, I should have no longer allocated assets to IWM even though IWM was in bullish alignment. My money should have been totally allocated to SPY from August forward.

Chart 5 – Monthly EFA with 6/10 Moving Averages

EFA closed 5.35% lower in December. It continues to trend lower as EFA remains in bearish alignment. EFA closed below the green line that could have represented a level of support, but that support failed to hold. Since EFA is in a bearish alignment, I won’t be allocating any of my retirement assets to EFA in January.

Chart 6 – Monthly EFA:SPY Relative Strength

Chart 6 shows that EFA outperformed SPY by almost 4% in December. While that is good, keep in mind how poorly SPY did in December. This ratio will be monitored moving forward.

Chart 7 – Monthly EFA:IWM Relative Strength

Chart 7 shows that EFA did outperform IWM in December by 7.52%. Consequently, the EFA:IWM ratio is back inside the green consolidation box. The ratio has spent most of its time inside this box. If the ratio can break above the green consolidation box, then EFA may enter a period of long-term outperformance over IWM. I will be watching to see when or if that happens.

Chart 8 – Monthly AGG with 6/10 Moving Averages

Chart 8 shows that AGG generated a buy signal in December. The strong 1.98% gain placed AGG in a bullish alignment, yet AGG stayed inside the green box, meaning that AGG is still in a sideways consolidation. Perhaps next month, AGG will break out from the sideways consolidation pattern it has been in since 2016.

Chart 9 – Monthly AGG:SPY Relative Strength

Chart 9 shows that AGG outperformed SPY by over 11% in the month of December. That large level of outperformance may be the start of a change of preference for investors. Investors may now prefer bonds over equities. The AGG:SPY ratio closed above its previous high set earlier in 2018. I will be monitoring this ratio in the upcoming months.

Is the market going into a prolonged decline? After being down almost 20% from October to December, is the bear market now over? I don’t know. My investing strategy says that all of the equity ETFs I follow are in bearish alignment. Consequently, I need to reallocate my retirement assets. For the month of January, I am changing my allocation to 50% AGG and 50% cash. The market may indeed rebound in January, but my method is to follow trends and is not to predict the future. I will continue to monitor all of my charts, and I look forward to 2019. Happy New Year everyone and good luck to all of you.

Disclosure: I am/we are long 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.

Additional disclosure: I will be selling SPY and IWM in the next two days and buying AGG.