Mid-Month Update: Worst Months Underway, Defense & Cash
By: Christopher Mistal
July 15, 2021
Perfectly on cue our Seasonal NASDAQ MACD Sell signal triggered on the last day of NASDAQ’s Mid-Year rally. Over the twelve-trading-day span that covers the last three trading days of June and the first nine of July, NASDAQ was up 2.0% this year. This is below average when compared to the past thirty-six years, but still a solid showing that extends the rally’s track record to up twenty-nine times in the last thirty-seven years. At NASDAQ’s Mid-Year rally high close on July 12, NASDAQ was up 2.6%, matching its average gain since 1985 before surrendering some of its gains during the last two days of the rally.
The appearance of NASDAQ’s Mid-Year rally is yet another sign that seasonality remains on track after getting overridden last year. The market is now entering its historically less favorable second half of July and the frequently treacherous August-September-October timeframe, aka the “Worst Four Months.” Even with the support of the Fed and Federal government spending, this year is not likely to be a repeat of last where the market sailed straight through this time period with only a few mild bumps and dips along the way.
In addition to concerns over Covid-19 variants, surging headline inflation metrics, interest rates, cyber-attacks and geopolitical events, bullish sentiment is still at concerning levels. According to Investors Intelligence Advisor Sentiment survey released yesterday, bullish advisors have climbed to 61.2% while correction advisors dipped to 23.5% and bearish advisors declined to 15.3%. They noted that bearish advisors are at their lowest levels since early 2018. In that year bearish advisors fell all the way to 12.6% before the market corrected. The limited number of bears is justified by recent all-time record highs, but from a contrarian point of view it is an issue as it would seem that everyone that wants to own stocks already does.
We acknowledge elevated levels of bullish sentiment or the lack of bearish sentiment can persist for extended periods of time. There is no exact line in the sand that once crossed triggers a market pullback or a correction. But as the pace of gains slows and volatility begins to creep back into trading few remain waiting on the sidelines to “buy the dip.”
Another area of the market we have been watching closely (and others have begun to notice as well) is market breadth. We noted the divergence in breadth last week in a blog post. In the time since that post the rift has only widened further. Thus far, DJIA and S&P 500 have largely been able to shrug it off, but small-caps measured by the Russell 2000 have been hit off 5.2% this month as of today’s close. NASDAQ has also weakened although not nearly as much, as mega-cap tech has held up and continued to climb. The downward trajectory of small-cap stocks and negative breadth in tech could easily pull the remainder of the market lower like it did in August and September 2019.
[Advance-Decline Line Chart]
Yesterday’s Seasonal NASDAQ MACD Sell signal is confirmation to shift from the neutral positioning that was in our portfolios since our Seasonal MACD Sell for DJIA and S&P 500 on April 22 to fully cautious and defensive posture. The Tactical Seasonal Switching Strategy ETF portfolio is now entirely in bond ETFs and cash. The Sector Rotation ETF portfolio has also been trimmed back to contain mostly defensive positions or short trade ideas. The Stock Portfolio has been taking profits, expanding its cash position and contains numerous defensive and/or dividend paying positions. All three portfolios are now positioned for the “Worst Four Months.”
Our outlook for the remainder of the year has not changed. We remain bullish for the full year but are cautious for the balance of the third quarter. Our best case scenario presented in the Annual Forecast is still on track and S&P 500 is still likely to finish the year in the 4300-4500 range or even higher. The pace of the gains made by the market and the economy is likely to slow as year-over-year comparisons become increasing more challenging and the trough low of the Covid-19 pandemic economic closure fades into history. At some point focus is going to shift from recovery to growth beyond the recovery. Sustained solid economic growth has proven to be rather sporadic over the last decade and this shift is more likely to hit the market sometime in midterm election year 2022.