Beginners Series Webinar: Join us on Friday, June 16th at 2 PM (ET) for our NDW Beginners Series Webinar. This week's topic is: Fund Score Composition and the Asset Class Group Scores Page. Register Here

Yesterday’s Were You Aware discussed a recent development on the Asset Class Group Scores (ACGS) page, which saw cap-weighted assets move above equal-weighted assets for the first time in over two years from an average score perspective. This comes off the back of a stellar rally for the broad indices, seeing SPX journey within 10% of all-time highs from December of 2021. While plenty of work is left to do before such a level would be a serious consideration, the mention alone of such a feat after a rocky 2022 speaks to the magnitude of recent upside participation. Yesterday’s article briefly discussed such an idea, with cap-weighted assets earning strong marks across many parts of our platform.

One of those areas was the recent flip of near-term relative strength (RS) between cap-weighted proxy SPY and equal-weighted proxy RSP on a 3.25 scale. As the funds are so similar, reversals (or eventual signal changes) are certainly worth noting and could be used as a sign of market attitude for the time being. As seen in the chart below, May’s reversal will mark only the 6th instance of such a change in nearly three decades. As with other relative strength charts on the platform, one could choose to employ a “switching” strategy, which simply invests in the asset that is in a column of X’s (or on a buy signal, but that won’t be used for today’s report), focusing your assets into the “winner” of the battle. Included below is a table of such a strategy. Note that the chart below considers being in a column of O’s as a preference for SPY, while a column of X’s suggests an investment in RSP. While not each reversal has been a “hit” by an outperformance standard, its worth mentioning that the strategy did shield investors (from a purely relative standpoint) from a bulk of the GFC, and has an impressive 42% average outperformance when the indicator is on the right side of the trade. Take that, in comparison to a 5% underperformance when the reversal “misses”.

As an added test, we ran our “switching” portfolio up against simply owning each asset on its own throughout the entire period (1/4/1994-6/15/23). The point being, we know our reversal portfolio does experience occasional “head fakes”, and are aiming to isolate a pure point A to point B scenario. As seen in the chart below, following such a strategy does indeed best a pure “buy and hold” strategy for each asset on its own. 

The Fed wrapped up its June meeting on Wednesday, leaving the target for the Fed funds rate unchanged at 500 – 525 bps, as had been widely expected. On the surface, the pause or skip in rate hikes could seem like a dovish pivot from the Fed, however, the rate decision belied a pronounced hawkishness in the summary of economic projections. The economic projections showed FOMC member’s median projection for core PCE this year, the fed’s preferred gauge of inflation, rose to 3.9%, up from 3.6% in March, while the median projection for the fed funds rate in 2023, climbed to 5.6%, up from 5.1%.  The upgraded projection for the fed funds rate indicates that FOMC members see two additional 25 basis point increases from the current target of 500 – 525 bps before the end of the year. The Fed futures market shifted following the meeting and is no longer pricing in a rate cut by the end of the year; a month ago, the market was pricing in nearly a 100% probability of at least one 25 bps cut by the end of the year, with a 75% chance of at least 50 bps of cuts.

The market seems to have digested the shift in expectations well, at least initially, the S&P 500 (SPX) closed at a fresh 52-week high on Wednesday and continued higher on Thursday, printing Xs at 4400 and 4420 on its default chart. Meanwhile, after rising initially, the 10-year US Treasury yield finished down on Wednesday and was lower again on Thursday, lifting bond prices.

The continued rally in US equities following the Fed meeting has pushed the major US indices even further into heavily overbought territory. SPX reached a weekly overbought/oversold (OBOS) reading north of 114% intraday on Thursday, its highest reading since January 2020 and the first time it has crossed the 110% level since August 2020. Meanwhile, the Nasdaq 100 (NDX) which has led the push higher, hit an intraday OBOS of 157%, which is higher than any weekly closing value in the data, which goes back to 1992. In January 1999, NDX reached an OBOS reading of 142.61%, the highest weekly closing value on record. It is certainly possible that NDX has reached more overbought levels on an intraday or intraweek basis, but it is clear the index is currently extended to near historic levels.

With the major indexes currently at historically overbought levels, one of the glaring questions is how much further can this rally go? Of course, we all know that the last time the S&P 500 was 115% overbought, in January 2020, it experienced precipitous drop a within a few weeks. However, given the events surrounding that collapse, it would be a stretch to conclude it was a reaction to the overbought state of the market. The last time SPX was more than 110% overbought, at the end of August 2020, the index pulled back roughly 4.5% over the next 30 days before ultimately resuming its rally and reaching a new all-time high in October. In January 2000, NDX reached 2000 and north of 140% overbought, the index pulled back to 1840 but ultimately reached 2100 before the end of the month.

Looking at these three examples, it may seem like a pullback is imminent. Keep in mind, however, we are looking at prior peaks in the OBOS, which all but necessitates that the market pulled back or consolidated shortly thereafter – if it had continued higher for another week or two, the OBOS would likely have continued higher as well. On February 28, 2020, the S&P reached -126% oversold, it's lowest reading since 2008 when it reached -148%, but the index dropped another 22% before bottoming on March 20 and reaching 184% oversold. The point is that the OBOS can tell us that a move is overdone, but not that it can't extend further and sometimes substantially.  

As mentioned above, SPX reached 4420 on Thursday, surpassing its bullish price objective of 4400. Meanwhile, the Nasdaq-100 closed at 15,225, a little more than 1% away from the 15400 bullish price objective on its default chart. Another data point suggesting that the current rally may be getting long in the tooth.  However, as mentioned in Wednesday’s report most of the bullish percent charts remain in the middle field position. The Bullish Percent for the NYSE (^BPNYSE) and Bullish Percent for the S&P 500 (^BPSPX) sit in Xs and 50% and 58%, respectively. Even the Bullish Percent for the Nasdaq-100 (^BPNDX) has yet to cross the 70% level, it currently sits in Xs at 66%. The field position of the BPs suggests there is room for breadth to increase, potentially allowing less-extended areas of the market to support a continued push higher.

Emerging markets have marched higher this week, leading the iShares Emerging Market ETF EEM to return to a buy signal as discussed in yesterday’s International Equity Overview. Another topic of conversation in the International Overview was Latin America – namely Brazil – which has been the primary driver behind recent performance within the emerging markets. China has been another emerging market to have a positive performance this week, but the breadth of funds showing positive absolute and relative performance within Latin America has led to scoring improvement. Looking at the Latin America group within the Asset Class Group Scores page and the group moved above the 5-threshold following Wednesday’s action. Latin America is the only group scoring above 5 and since sits in first. This is the first time since the latter part of 2017 the group has been above this threshold, and Latin America leads Japan and Europe among those groups scoring above 4 and in the blue-sky zone.

Over the past decade, there have only been a handful of times that Latin America has attained a score of 5 or above, and many were brief lasting less than a single trading week. There has only been one period over the last decade that the Latin America group has maintained above 5 for two weeks of trading or more.  Most of the periods in which Latin America scored above 5 came during the early to mid-2000s; bear in mind the score data set for the group begins in November 2003.

With the Latin America group moving above 5, we ran performance while the group remained above the 5 thresholds as well as looked at forward returns following the group moving above the score of 5. The proxy utilized for the performance of the region is the iShares S&P Latin America 40 ETF ILF due to its trading history and volume. Since November 2003, there have been ten instances in which the Latin America group scored above 5 for more than just a couple of weeks’ worth of trading (eliminating clusters within the same month). As noted above, many instances occurred from 2003 (the beginning of the score data set) through 2008 and there has only been one instance of the group scoring above 5 that lasted longer than a couple weeks within the last decade. On average, when the groups maintain above 5 for more than a brief couple of weeks, ILF has been up over 15% and the group has maintained above the 5 threshold for just shy of a full quarter.

Looking at forward returns of ILF following the Latin America group moving above the 5-threshold yield similar positive results. On average, ILF has positive returns across all the observable forward time frames, and the majority of the instances were positive with at least 80% being positive from 1-week to 6-months. Although the 12-month period had six out of ten instances positive, the last four occurrences saw ILF down more than 16% 12 months after reaching a score of five.

Whenever the Latin America group can maintain a score above five for more than just a couple of weeks, results have been positive. With the group just moving above the score of 5 on the Asset Class Group Scores page there is no way to say that the group will maintain there for two or more weeks or not. Initial exposure to the Latin American region could be taken – if it hasn’t already – and then monitored for that 2-week threshold of the Latin America group scoring above 5. This would then provide further evidence that the group’s strength isn’t just a flash in the pan, and investors could confidently increase exposure knowing returns have been positive within six months. 

Daily Option Ideas for June 15, 2023