In May, we announced the launch of the Nasdaq-100 Dorsey Wright Momentum Index. As a brief refresher, the Nasdaq-100 Dorsey Wright Momentum Index is composed of 21 equal-weighted stocks within the Nasdaq-100 universe with superior Relative Strength/momentum characteristics. The index is evaluated and reconstituted/rebalanced quarterly on a Jan/Apr/Jul/Oct cycle. To construct the index, we utilize the Nasdaq-100 Total Return RS Matrix located under the “Premade Matrices” section of the NDW Research Platform. Like many of our matrix-based strategies, we start by buying the top 21 ranked names in the Nasdaq-100 RS Matrix and only sell them once they fall significantly out of favor to reduce turnover. Once a position moves low enough in the matrix to warrant its removal, we sell it and then buy the highest-ranked security that we do not already own to replace it. In this way, we consistently rotate the portfolio out of relative underperformers and into relative outperformers over time. To read more about the approach behind the index, click here to read our whitepaper titled, “Applying Momentum to the Nasdaq-100 Index.”

The Index saw its first evaluation earlier in the month of July, which resulted in eight names being sold and eight new names being added. These new additions saw the exposure toward technology lose the most of any sector, however, the sector remains overweight within the portfolio at over 42% of the index. Healthcare saw the largest gain of any sector, increasing over 14% to an allocation of 23.81% following the latest evaluation. Each of the current index holdings can be found below, along with the breakdown of sector weights within the index.

Market action Friday saw the last trading day for the month of July, which resulted in the S&P 500 Index SPX ending the week slightly lower but finishing the month at a gain of more than 2%. As we head into August, the S&P 500 sits less than 1% off its all-time chart high of 4420 that was reached for the second time this month in trading Thursday. The index has also seen a positive return in each of the last six months, with five out of those six months seeing a gain of at least 2%. The consistent improvement from the core market benchmark has certainly been welcomed by investors, but also raises the question of just how long this improvement can continue. The US equity market has proven repeatedly to look past eye-catching negative headlines while moving higher. However, the three-month span ahead of August through October has certainly seen some intense market movement throughout history.

To examine these moves further, we have taken the average, minimum, and maximum returns for the S&P 500 monthly from April 1987 through June 2021. This data reveals that the upcoming month of August has shown the second-lowest minimum decline of any month in our testing history, at a loss of 14.58% in August 1998, with October having the lowest minimum at a -21.76% return in 1987. August is also one of only two months to show a negative average return, with the other being September. Furthermore, August showed one of the lowest maximum returns of any month.

The percent of positive returns for each month in our testing timeframe saw August as the second-lowest percentage at 56% of the years since 1987. September showed the lowest percentage at just 50% of the years. Even though the months of October through November have shown some intense drawdowns, the percentage of those months with positive returns increases as you move closer toward the end of the year.

We also examined the average, minimum, and maximum return for SPX over three-month rolling time periods beginning with November through January and ending with October through December. This data showed that the July through September timeframe had the lowest average return and was the only average in the red at -0.88%. The second-lowest average was the three-month span from August through October, which also saw the second-worst minimum return at -24.48%.

This data does not necessarily mean that the upcoming month is due for sharply negative returns, as there have been many instances of positive returns in August historically. Domestic equity markets also continue to rank highly in our relative strength comparisons and have shown a recent uptick in participation through indicators such as the Bullish Percent for NYSE ^BPNYSE, which reversed back up into a column of X's following trading Thursday. With that said, the historical tendencies for more muted returns in the months of August through October should certainly be considered when making asset allocation decisions, as it is especially important to maintain exposure toward those sectors with increased relative strength or individual equities that possess favorable technical attributes.

The historic strength of the broad S&P 500 Index funds group can hide the shift in strength of other asset classes. On the domestic equity front, the sectors that were leaders for much of the year have shown significant deterioration in their scores. Most notably are the two financials groups which were not only ranked high on the sector view, but also on the entire asset class group scores system. Consumer cyclicals, transportation, and industrials are following the same path. On the other hand, real estate, technology, and utilities have improved the most over the last six months. This is a bit unusual. Two of these three sectors are typically associated with defensive asset allocations while the third, technology, has a much more risk-on nature.

One thing to keep in mind is that many of the mega-cap names that drive the S&P 500 are within the technology sector and mega-cap names can be viewed as defensive when compared to small and mid-caps which are more risk-on groups. This is also what we’re seeing in terms of score directions of US styles, small caps have substantial negative score directions while the large-cap groups are either positive or essentially flat. Large-cap growth leads all other US styles groups in terms of score direction and is close to passing micro caps in terms of average group score which would put it in a position to pass the S&P 500 Index Funds group next.

Outside of the equity space, the movement in fixed income groups has also been noticeable when looking through a risk-on versus risk-off lens. The most improved fixed income groups are long-duration bonds, inflation protection, investment grade, and US quality fixed income. The fixed income group with the worst score direction is convertible bonds, which is on the surface surprising given the broad equity markets seem strong, but this can also be viewed as risk-off behavior. International fixed income groups are also showing signs of deterioration.

While much of the changes in strength can be viewed as risk-off behavior, further confirmation is needed before any major changes to asset allocations need to be made. However, keeping a close eye on these relationships will be important moving forward. This is a very good time to go through client’s portfolios and see if there are places that may need to be trimmed back on, specifically in groups that have shown signs of weakness. For example, small caps may still be lingering in many of your clients’ portfolios after their strength at the beginning of the year. As always, remember to visit the Asset Class Group Scores page to stay on top of any market trends and changes.

Daily Option Ideas for July 30, 2021