Market Update for the Week of June 27th, 2022
There have been very few places for investors to hide this year. The S&P 500 (SPX) and Nasdaq Composite (NASD) are each in bear market territory and bonds are not offering protection due to the velocity, trend, and expectation of rising interest rates. All but one of the 11 major stock sectors are negative YTD, with the exception being energy, which we will discuss in more detail later. You know it has been a tough year when the second and third best-performing sectors are Utilities and Consumer Staples with losses of -6% and -8%, respectively (through 6/22 source: Nasdaq Dorsey Wright).
This predicament is perhaps best evidenced by the historically weak performance from the traditional 60/40 portfolio – 60% being allocated to broad market stocks and 40% to broad market bonds. So, with the broad benchmarks suffering, active investors had, and still have, an opportunity to earn some stripes.
Source: Nasdaq Dorsey Wright
A Time for Tactical Investment Management ~ As longtime proponents of tactical investment management, within the Domestic Equities (U.S. Stocks) portion of our overall tactical strategies, we use the First Trust Dorsey Wright Focus Five Model.
The Focus Five Model (FTRUST5) is designed with the goal of providing access to a handful of relative strength leaders within a broader inventory of ETFs. More specifically, the strategy has a ruleset that allows it to efficiently rotate when needed based upon relative strength. At each bi-monthly evaluation (every two weeks), it seeks to own five U.S. sector-based funds out of an ETF inventory from 20 First Trust ETFs. Relative strength is the only input for selecting the sectors that are either in or out of the model. If a position falls out of the top half of the relative strength matrix ranking upon the evaluation date, then that sector is removed and replaced with the highest-ranking sector that is not already a holding.
During the 12-year history of the Focus Five Model, it has experienced periods of underperformance and outperformance, but over time, the tactical process has proven worthwhile. Along with other successful relative strength/momentum strategies, its tendency to let winners run and cut losers short has been a distinguishing factor. Furthermore, its ability to drastically change its sector composition has been a large contributor to its outperformance relative to passive benchmarks like the S&P 500 – especially throughout 2022.
Sometimes it is more about what you don’t own versus what you do own. For example, the Focus Five Model began reducing its overweight technology exposure in January of 2021. Then, in December of 2021, the strategy further distanced itself from technology by selling another position that had been a longstanding holding. In place of these two funds, the Focus Five Model added the Industrials/Producer Durables and Oil & Gas in January and December, respectively. In March of 2022, the theme continued – the Focus Five Model added more energy exposure and eliminated its last technology position.
These changes felt very drastic at the time, given the long run and persistent relative strength from technology over the past decade; however, the rotation paid off as technology has continued to tumble.
A Word on Energy ~ Although energy remains the best performing sector YTD, it has come under pressure in recent weeks. These moves are technically concerning, but the recent weakness has not been enough to cause the Focus Five Model to begin reducing its exposure to the sector.
If a 20% pullback doesn’t result in a model change, then what will? We would first like to note where energy is pulling back from. In most instances, the current pullback is coming after a 50% gain, and for the energy space, a pullback of this magnitude following such an intense rally is not uncommon. Second, keep in mind that relative strength/momentum strategies are not designed to exit at tops or enter at bottoms because they are built to identify trends of leadership. One week of price action is (usually) not enough to change a trend. Third, note the evaluation periods. As mentioned before, the Focus Five Model is evaluated every other week, so there can be times when a potential change is evident, but it would not take effect until the evaluation date.
In theory, price softening in the energy space could be bullish for the broader market. However, we will refrain from trying to jump model changes in anticipation of such because it would violate the benefits of using a rules-based and objective process. The Focus Five Model will adapt should these trends materialize.
The current reading for the Nasdaq Dorsey Wright PR4050 Cash Trigger is: Money Market = 65.49% & U.S. Equity Core = 81.69%. For the PR4050 indicator to trigger and alert us when we should consider moving to cash, Money Market must be 50% or above and U.S. Equity Core must be 40% or below.
Below is the most recent DALI (Dynamic Asset Level Investing) Indicator showing Commodities maintaining first place and Cash extending its lead over Domestic Equities for second place. International Equities and Fixed Income are in a close battle for third place.
Switching to the economy, below is the most recent Recovery Tracker from First Trust Advisors showing the 2019 level, month-over-month (MOM), and week-over-week (WOW) comparisons of high frequency economic data.
Source: First Trust Advisors
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Main Street Wealth Advisors33801 1st Way South, Suite 271Federal Way, WA 98003Office: (253) 944-1047Fax: (253) 944-1075www.mainstreetwa.com
LPL Financial did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of LPL Financial or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.
Past performance is no guarantee of future results. All investing involves risk including the loss of principal. Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.
Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future. Nasdaq Dorsey Wright developed the indicators described above. They have been prepared without regard to any particular investor's investment objectives, financial situation and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Any statements nonfactual in nature constitute only current opinions and interpretations of their indicators, which are subject to change without notice. There may be instances when fundamental, technical and quantitative opinions may not be in concert. Any opinions expressed or implied herein are not necessarily the same as those of LPL Financial or its affiliates. Any market prices are only indications of market values and are subject to change. The material has been prepared or is distributed solely for informal purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Data and opinions are current as of 6/24/22. Additional information is available on request. Nasdaq Dorsey Wright’s “DALI" employs relative strength-based analysis to rank macro asset classes based on developing leadership trends within the global capital markets. The objective guidance within DALI provides the tools necessary to properly allocate portfolio across all major asset classes in an effort to emphasize strength wherever it exists. Domestic Equities, International Equities, Commodities, Currencies, Fixed Income and Cash are evaluated daily to identify dynamic developments across investment genres, as well as within them. This tool provides the tactical precision that allows investors to adapt as the market leadership changes.
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