January started off the year much in the same way as 2017 ended, on a positive note with low market volatility. Turn the calendar to February and we have seen a very different picture than what has transpired over the course of the past couple years as market swings and volatility has spiked. But what does all of this mean?
First and foremost, it does not mean we need to panic, much to the dismay of the media. Rather, we need to ensure constant focus and attention on the how the market movements are affecting our risk and leadership indicators. In short, the market (both the S&P 500 and the Dow) peaked on January 26th hitting new all-time highs. Since January 26th through February 9th the S&P 500 and the Dow down are each down about 9%; however, that only begins to tell the story. The 10 trading days following the market's all-time peak saw six swings of more than 1% (five of those were down days), three days down more than 2%, and one day of down more than 4% (Note: The Dow experienced two -4% down days). While the magnitude of what transpired over the past ten days is not uncommon, the speed and frequency is what was the most shocking.
Volatility over the past couple of years has been low by many different measures. Historically, the S&P 500 has experienced a 5% pullback three to four times per year, and roughly one 10% each year. The last 5% pullback the market experienced was in the summer of 2016, and the last 10% pullback was in the January/February 2016 time period. In other words, the market had gone two years without experiencing a 10% pullback until the past 10 days where the S&P 500 was down 11.8% from the January 26th peak to the February 9th intraday low.
In the midst of this market action, one of main risk indicators, the NYSE Bullish Percent (BPNYSE) reversed into a column of Os, falling from 70% down to a current reading of 46%. Although the BPNYSE is now in Os, it is important to mention the reversal occurs while the US Equity asset class remains the #1 ranked asset class in our Dynamic Asset Level Investing tool, or DALI, which historically results in market stability rather than weakness. The Bullish Percent is a risk barometer, and it is best used to help you make plans for a scenario in which high risk turns into a bearish reality and has provided important guidance for many years.
The data below makes the case for an alternate approach using risk barometers such as the NYSE BP. When the bullish percent is on defense, but the US equity asset class is ranked #1 in DALI, markets tend to hold up better, on average. When the asset class moves out of favor (i.e. US Equity falls out of the top two spots) and markets are on defense, a very different story often unfolds.
For the purposes of this study, we have looked very specifically at defensive periods in "strong markets", and defensive periods in "weak markets" and we defined a "strong" market any time when Domestic Equities were ranked #1 or #2 in DALI, while a "weak" market was any period where US Equities were ranked #3, or lower. Some talking points follow:
- As evidenced in the data below, "strong market," high risk rarely becomes a bearish reality. However, the outcomes are quite different when the market is on defense and the asset class is ranked #3, or lower.
- The average return for "strong markets" (Domestic Equity in Top 2 / BPNYSE in Os) is 2.30% for the S&P 500 while for "weak markets" (Domestic Equities Below Top 2 / BPNYSE in Os) it's -1.16%.
- A positive average return during defensive periods in strong markets suggests that moving to 100% cash, or net short, when the NYSE Bullish Percent reverses down at a time when Domestic Equities hold one of the top two positions in DALI has historically been a painful endeavor.
- Reversals into Os for the ^BPNYSE when Domestic Equities are a "weak" asset class has helped to mitigate some of the most devastating market declines since 1999. Going forward, we continue to put an emphasis upon US Equities as it remains the strongest asset class.
While we do not intend to belittle the evidence that selling pressure has been on the rise, and volatility has come back from the dead, we must also recognize that we are still operating in a market that offers long term bullish indicators. For now, the move in the S&P 500 has functioned much like a "reversion to mean." Will the sell-off continue? Will we see another record down day? Unfortunately, there is no way of knowing what the outcome will be, but it is our job to demonstrate the ability to handle whatever the market has to offer. Handling the market means that you have a game plan to manage your positions based on risk parameters of your account. This is a great time to demonstrate the value that you bring to the table. Although there are more long term "pros" than "cons" in today's market, there are positions that have violated trends or the reason for owning them has changed, so it will be important to handle such conditions accordingly. With all of this said, be sure to stay on top of the latest updates from the indicators that we looking at through the Daily Equity Report, weekly videos, and podcasts. Additionally, the analyst team is here to take your calls and discuss specific situations you are faced with today and can be reached at 804-320-8511.
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The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.
Unless otherwise stated, the returns do not include dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance, hypothetical or actual, does not guarantee future results. In all securities trading there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives.
The performance numbers above are price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.