The Word from Main Street

Market Update for the Week of January 30, 2023

2023 has started off positive for U.S. stocks, with the S&P 500 up nearly 5% year-to-date (through 1/25), however, the market is on rocky footing as worries about inflation and recession remain. Even if we finish the year in the red, which would be the first consecutive negative calendar year returns for the S&P 500 since the early 2000s, there will almost certainly be areas of strength, as we typically see wide dispersion between the best-performing and worst-performing sectors regardless of whether the market as a whole is up or down. Throughout the Nasdaq Dorsey Wright Sector vs. Market Timing study, from 1993 through 2022, the S&P 500 posted a negative calendar year return six times, but there were only two years – 2002 & 2008 – in which all of the Dow Jones sector indices finished the year in the red. Last year, when the S&P 500 was down nearly 20%, the Dow Jones US Oil & Gas Index was up more than 60%.

We believe the study can be a useful tool both for coaching clients to stay the course in a turbulent market like the one we found ourselves in 2022, and for explaining intra market dispersion and the value of relative strength strategies.

Dispersion refers to the performance difference between the best and worst-performing assets and quantifies the opportunity available to tactical strategies. Relative strength-based strategies tend to offer excess return over their benchmarks more readily when the dispersion between the best and worst performers is very wide. The reason for this is straightforward - the more divergence that exists between the best and worst performers, the more potential value can be added by owning good-performing assets and avoiding the bad performers. When there is more dispersion, there is more potential for a tactical decision to produce a meaningful result. On the other hand, such strategies will tend to suffer or at least become muted when the dispersion is narrow. Taken to an extreme, if all investment possibilities were up the same amount each month and each year, tactical management would have no opportunity to add value via rotation. From 1993 through 2022, the calendar year dispersion between the best- and worst-performing broad Dow Jones sector indices have ranged from a low of just over 25% in 2012 to a high of nearly 97% in 1999 and 2022, with an average of a bit under 45%. In most years, the sector dispersion has been greater than the total return of the S&P 500, meaning that there was potentially more to be gained from sector allocation than from deciding between the S&P 500 and cash, as the study further illustrates.    

The Sector vs. Market Timing study tracks the return of four hypothetical investors over 30 years, from 1993 through 2022. "Mr. Buy & Hold” simply buys the S&P 500 Index and rides it up and down, making no movements at all in the portfolio. "Mr. Perfect Market Timer" is assumed to be clairvoyant and is only invested during months in which the S&P 500 Index is up. In 2008, for example, this investor would have only been invested in April, May, August, and December, as those were the only positive months that year. We believe this is about as "perfect" as any "market timer" could ever hope to be, and thus we feel this quantifies well as the best-case scenario for market timing.

The last two investors are both sector investors, one of whom, "Ms. Perfect Sector", has the ability to know each and every year what the best-performing sector will be for that year, and invests 100% of her portfolio in just that one sector. "Mr. Worst Sector" is an unfortunate fellow who perhaps just follows a favorite magazine cover and is on the wrong side of things every year. He manages to invest only in the single worst-performing sector.

 

Source: Nasdaq Dorsey Wright

As you might imagine, each of the investors has seen dramatically different results over the years from their initial investments of $10,000 back in 1993. At the end of 2022, “Mr. Buy & Hold” had a portfolio value of about $158,500 while Mr. Perfect Market Timer had a portfolio value of nearly $20 million. Ms. Perfect Sector saw her portfolio swell to $ 56.4 million all while poor Mr. Worst Sector's portfolio was worth only $289! Yes, you read that right - $289 from the starting point of $10,000.

So, it's easy, right? All you have to do is invest in the best-performing sector each year and simply walk away. Unfortunately, it is not that easy, nor are we advocating that you try to pick the best-performing sector and put all your eggs in one basket; rather, this is simply a powerful illustration of just how important incorporating a sector rotation plan can be into your overall portfolio strategy. It can also be an eye-opener for investors in that the magnitude of buying the best sectors is even greater than that of being able to perfectly time the overall market.

As part of our Tactical Trend process, we will continue to overweight the highest-ranked asset classes and underweight, or avoid, the lowest-ranked asset classes.

The current reading for the Nasdaq Dorsey Wright PR4050 Cash Trigger is: Money Market = 16.90% & U.S. Equity Core = 82.39%. 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.

 

Source: Nasdaq Dorsey Wright

Below is the most recent DALI (Dynamic Asset Level Investing) Indicator showing International Equities extending its lead over Cash while Commodities continues to outpace Domestic Equities.

Source: Nasdaq Dorsey Wright

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Main Street Wealth Advisors
33801 1st Way South, Suite 271
Federal Way, WA 98003
Office: (253) 944-1047
Fax: (253) 944-1075
www.mainstreetwa.com

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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 1/27/23. 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 portfolios 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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