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  • Guided Allocation

    Market Pulse Signal: Reducing Equity Exposure as Turbulence Roils Markets

    Ed Lopez, Head of ETF Product
    December 04, 2018

    Today the Market Pulse model reduced its equity allocation from 100% to 80%. The change was precipitated by a declining trend in the Composite Score, the model’s measure of market breadth. Notably, although the trend recently turned negative, breadth is still relatively broad at 67.9. Thus, the change is a risk management action more akin to putting on your seat belt rather than abandoning ship.

    The model took similar measures in April of this year as volatility began to reappear in the market. It returned to 100% equity in August as market breadth improved. Since then, the media and entertainment, technology hardware and equipment, and retail industries have contributed most to the recent downturn in the S&P 500®. The largest detractors in each group were Facebook, Apple, and Amazon, respectively.

    At a time when the U.S. equity bull market is considered by many to be in the late stages and is increasingly driven by fewer names, more turbulence may be in store. In our view, it makes sense to take a few chips off the table, but not all. The composite score is still relatively high, and the market may continue to defy calls for its demise a little longer. The intention of the model after all is to help investors avoid major market downturns, but still be able to meaningfully participate in potential equity upside.

    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®1  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

    Equity Allocation Based on Level and Trend of Composite Score

    Composite Declining Increasing
    Above 70 100% 100%
    Between 60-70 80% 100%
    Between 50-60 40% 100%
    Below 50 0% 100%

    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 thrusts3 often 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

    As of November 30, 2018, the year-to-date return of the Ned Davis Research CMG US Large Cap Long/Flat Index, which is informed by the model, was 3.02% versus 5.11% for the S&P 5004. There have been three allocation changes this year:

    Signal Changes
      Composite Equity Allocation %
    Signal Date Score Trend Prior After
    4/10/2018 67.62 Decreasing 100 80
    8/29/2018 65.91 Increasing 80 100
    12/4/2018 67.9 Decreasing 100 80

    View the daily updated model.