Market Pulse Signal: Equity on Full as Bulls Devour Tech Like It's 1999
Ed Lopez, Head of ETF Product
October 18, 2018
Market Breadth Improved
After fully allocating to equities on August 29, 2018, the Market Pulse model that informs the Ned Davis Research CMG US Large Cap Long/Flat Index saw its positive trend continue as market breadth improved. Since the change, healthcare stocks contributed most to returns while financials and the new communication services sector softened modestly. Still, for the quarter ending September 30, 2018, technology and healthcare stocks were the main contributors to the S&P 500®’s ongoing ascent.
No matter how you calculate it, the U.S. equities market has experienced one if its longest bull runs, if not the longest, in history. Technology stocks, even after recent GICS®1sector reclassifications, made up over 20% of the S&P 500, a level of sector concentration not seen since before the Tech Bubble of 2000. Tech stocks went on to become over 30% of the market before the Tech Bubble burst. Considered another way, over 40% of the S&P 500’s return through September 30, 2018 came from only four stocks. In 1999, over 40% of the full year return of the S&P 500 was attributed to five stocks. Over the last 19 years, the only other sector to see exposure in the S&P 500 of over 20% was financials, before the 2007-2009 Financial Crisis.
In a recent webinar, Running with the Bulls Safely in Today’s Market, we explored the current state and outlook of the market with Robert Schuster of Ned Davis Research (NDR) and Steve Blumenthal of CMG Capital Management Group, Inc. According to the many indicators NDR looks at, the economic backdrop looks stable at least until the middle of next year, a pre-election year, which is generally the weakest year of the four-year election cycle.
Nonetheless, the stock market is a leading indicator. Given the age of the bull market, corrections may occur before a recession is evident, as we have seen in the first week of October. While still just a correction, you just don’t know when a correction will turn into the next bear market or bounce back to continue making new highs.
How the Market Pulse Model Works
The Index’s model (i.e., Market Pulse) measures the overall health of the market through an evaluation of market breadth. In this case, market breadth refers to advancing and declining price trends and countertrends at the GICS®industry group level. The model computes a robust moving average score daily to capture multi-industry and multi-term trend and countertrend measures to gauge overall market health. It then calculates the score’s directional trend to see if it is improving or declining. Collectively, the score and its directional trend determine the equity allocation of either 100%, 80%, 40%, or 0%. At 0%, the allocation would be entirely to cash.2
Allocations Based on Level and Trend of Composite Score
There are a few key reasons why measuring market breadth provides sound trend analysis for guiding equity allocations. Steve Blumenthal of CMG Capital Management Group, Inc., the Index’s co-developer, wrote a whitepaper, Risk Management for all Markets, detailing this tactical approach. Mainly, market breadth has typically weakened before top-line prices have at major market peaks, and breadth thrusts3often occur just before major bull market recoveries. Furthermore, the S&P 500 is considered a very efficient market, meaning the underlying securities’ fundamentals and macro environmental factors tend to be priced in almost immediately.
Market Pulse Model Update
The model remained 100% allocated to equities through quarter-end September 30, 2018, after a recent allocation change on August 29, 2018. Year-to-date the model has returned 8.36% versus 10.56% for the S&P 5004. There have been two allocation changes this year:
On April 10, 2018 the model reduced equity allocation to 80% as the directional trend of the Composite Score had turned negative. Reactions to the escalating trade tariffs and an embattled technology sector induced a more pronounced risk-off market sentiment, and the S&P 500 had turned negative for the year.
On August 29, 2018 the model allocated to 100% equity as the Composite Score trend turned positive. Market health began to improve beginning late July after another strong earnings season.
Signal Changes and Current Level Year-to-Date
Equity Allocation %
Year-to-Date Cumulative Return (%)
Source: FactSet. Data as of September 30, 2018. Past performance is no guarantee of future performance. Index performance is not indicative of fund performance. Indices are not securities in which investments can be made. Index returns do not reflect a deduction for fees & expenses. See index descriptions and additional disclosures below.
1Global Industry Classification Standard (GICS®) is a widely accepted equity securities classification system developed by Morgan Stanley Capital International (MSCI) and Standard & Poor’s.
2Allocations to equities (long) represented by the S&P 500 Index. Allocations to cash (flat) represented by the Solactive 13-week U.S. T-bill Index.
3Source: Ned Davis Research. Breadth thrust is a technical indicator used to ascertain market momentum and signals the start of a potential new bull market after what may have been an oversold market.
4Source of all data unless otherwise noted: FactSet and Ned Davis Research. Data as of 9/30/2018.
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