ETF Trades: Modest Rate Cuts Best By: Christopher Mistal | July 11, 2024 | Email | Print

In case you missed the member’s only webinar last Wednesday (July 3), the slides and video recording are available here (or copy and paste in a new browser window: https://www.stocktradersalmanac.com/LandingPages/webinar-archive.aspx). In the webinar we reviewed our July outlook, key seasonal pattern charts that we have been tracking throughout the year, current GDP and inflation trends, Fed interest rate expectations, the end of NASDAQ’s Best Eight Months, NASDAQ’s Midyear Rally and what we expect during the balance of the “Worst Months.” We also took questions from attendees. One question that came up then and a few times via email since was about the impact of Fed rate cuts on the market. Today’s better than expected CPI report has greatly improved the odds of a Fed rate cut in September, making this topic even more relevant now.

 

Changes in Fed Funds rate is a topic we explored in May 2022 as the Fed began increasing interest rates. Here is what we found then, updated with 2022 and 2023. Using Federal Funds Effective Rate data, available at St. Louis Fed’s FRED database, since July 1954, we compiled the following charts. The first two charts of the S&P 500 and NASDAQ offer a quick comparison of a few basic scenarios. Based upon the annual change in Fed Funds Effective Rate, data was grouped into three categories: Higher, Lower, and No Change (NC). For NC, a range of plus/minus 0.2% was used. The All line represents all years in the data set.

 

 

On average, it would appear as though changes in Fed Funds Rate generally did not have a significant effect on the S&P 500 or NASDAQ. Years where Fed Funds Rate did not change or changed less than +/- 0.2%, historically performed the best. On average S&P 500 averaged just under 12% for the full year while NASDAQ averaged over 25%. The most recent year to fall into this category was 2021. 

 

Higher Years and Lower Years failed to show any substantial deviation versus All Years. This was a somewhat surprising result considering the biggest increase in one-year rates was 7.23% (from 14.77% at the end of 1979 to 22.00% at the end of 1980). In 1980 the S&P 500 gained 25.8% and NASDAQ rose 33.9%. The largest one-year decrease in rates was 8.87% (from 22.00% at the end of 1980 to 13.13% at the end of 1981). In 1981, S&P 500 declined 9.7% and NASDAQ fell 3.2%.

 

 

In these next two charts we expanded the number of categories that a given year could fall into based upon the magnitude and direction of the change of Fed Funds Rate. With this approach one group easily stands out while the rest still exhibited relatively subtle changes. Years in which Fed Funds Rate was cut by 2% or more, were a disaster on average. Which is consistent with current Fed practice of rapidly lowering Fed Funds Rate in response to adverse economic conditions. These years were 1974, 1981, 1987, 1990, 2001, 2007 and 2008. Prior to the Covid-19 Pandemic, Fed Funds had declined in 2019 and was only cut 1.46% in 2020 (1.55% at yearend 2019 to 0.09% at yearend 2020).

 

NASDAQ appears to perform best when rates are unchanged or modestly lower (no more than a 2% drop in a year). S&P 500 also appears to favor unchanged to modestly lower rates but appears to be more resilient when annual increases were less than 2%. Interest rates do play a role in the market’s overall performance, but it is not the only factor. Employment, overall economic growth, inflation, and taxes all impact corporate earnings. Sentiment and momentum can also drive prices to levels (up and down) that may appear to have little to no connection to reality. Barring an external trigger or major economic calamity, the Fed appears to be nearly ready to embark upon slowly returning rates to a neutral range. Based upon past occurrences, future modest cuts in rates are likely to keep the bull market alive and well. However, this does not eliminate the possibility of some near-term seasonal weakness during the “Worst Months.”

 

 

Three new sector seasonalities begin in the month of July. First up is a bearish seasonality in Transports which typically begins in the middle of July and lasts until the middle of October. This seasonality is based upon the Dow Jones Transportation index (DJT). Over the last 10- and 25-year time periods DJT has declined 1.23% and 6.25% on average during this bearish period. Industrials also exhibit similar weakness to the transports sector over nearly the same timeframe.

 

iShares Transportation (IYT) is a top choice to establish a short position in to take advantage of seasonal weakness in the transport sector. IYT has over $700 million in assets, has traded an average of over 300,000 shares per day over the past 30 days and has a reasonable 0.40% expense ratio. IYT’s top five holdings include: Uber, Union Pacific, United Parcel Service, FedEx and Old Dominion Freight.

 

 

IYT has been trending lower since late March flattening its 200-day moving average and pulling its 50-day moving average lower. IYT’s late May low appears to have been tested in mid-June, but shares have remained rangebound. Today’s sizeable gain by Uber on news that Tesla is delaying its Robotaxi is not likely going to stick as Uber still faces numerous other headwinds. IYT could be shorted on a breakdown below $63.23. If shorted, consider an initial stop loss at $65.50.

 

SPDR Industrials (XLI) will be our choice to establish a short position to trade seasonal weakness in the industrial sector. XLI has over $18 billion in assets and frequently has 5 to 10 million shares changing hands daily. Its expense ratio of 0.09% is very reasonable. Top five holdings of XLI include: General Electric, Caterpillar, Uber, Honeywell, and Union Pacific.

 

 

XLI’s chart and technical indicators do not differ much from the chart of IYT. XLI even experienced similar softness since late March, just to a lessor magnitude. XLI could be shorted on a breakdown below $119.62. If shorted, set an initial stop loss at $123.50, this level is just below projected monthly resistance (red dashed line). Please note that the (S) after IYT and XLI in the portfolio table below denotes a short trade.

 

July’s final seasonality is for gold & silver mining stocks. This seasonality is based upon strength in the Philadelphia Gold & Silver index that typically begins in late July and lasts until late December. Over the past 10 years this trade has struggled, but more recently in the last 5 years it has averaged 7.35%. With September rate cut odds rising on today’s better than expected CPI report, gold, silver, and their miners are all solidly higher today.

 

VanEck Gold Miners (GDX) is our preferred ETF to take advantage of seasonal strength in gold and silver miners. As of the close on July 10, GDX had over $14 billion in assets with an expense ratio of 0.51%. Top five holdings of XLI include: Newmont, Agnico Eagle Mines, Barrick Gold, Wheaton Precious Metals, and Franco-Nevada.

 

 

After spending much of June consolidating earlier gains, GDX broke out to new highs today. Stochastic, relative strength and MACD indicators are all positive and trending higher. GDX can be considered on dips below $37.00. If purchased, set an initial stop loss at $32.70 and an auto sell at $48.28.

 

 

We will also look to establish a position in SPDR Gold (GLD). Like the miners, physical gold also enjoyed solid gains today and GLD is on the verge of breaking out to a new high. After consolidating throughout June, GLD has reclaimed its 50-day moving average and appears to be regaining upside momentum with Stochastic, relative strength, and MACD indicators positive and trending higher. GLD can be considered on a dip below $220.10. If purchased, consider a stop loss at $208.39.

 

 

Per our Seasonal MACD Sell for NASDAQ emailed after the close on June 25, SPDR Consumer Discretionary (XLY) and SPDR Consumer Staples (XLP) positions established last October 5 were closed out of the portfolio on June 26 with gains of 9.0% and 15.4% respectively. Please note, there is still a “Worst Months” position in XLP in the portfolio and it can still be considered on dips below its buy limit.

 

With crude oil back above $80 per barrel and showing signs of strength, we are going to continue to hold SPDR Energy (XLE). Oil’s seasonally bullish period has historically ended in early July. In light of this, we are going to implement a 1% trailing stop loss based upon its daily closing price. Starting with today’s close of $90.25, the stop loss is $89.35. Stop only if XLE closes below this level and update daily should XLE continue to rise.

 

 

 

Per our Seasonal MACD Sell for NASDAQ, Invesco QQQ (QQQ) and iShares Russell 2000 (IWM) were sold and closed out of the portfolio on June 26. QQQ recorded a 30.0% gain since our Seasonal Buy Signal last October. IWM lagged during the Best Months, but still managed a respectable 13.7% gain excluding dividends and any trading fees.

 

With the odds of a rate cut for September improving, TLT, AGG, and BND can be considered on dips below their respective buy limits. Should inflation continue to aggressively cool alongside a softening labor market and economic growth, these ETFs could finally see some upside. However, if that does not transpire, then they could also dip into the red. For tracking purposes, we will add to existing positions should TLT, AGG, or BND trade below their buy limits.

 

SHV and SGOV can still be considered at current levels. Yields on 1- to 6-month Treasury bonds currently remain above 5% which is likely to ensure the yields of SHV and SGOV remain at or above 5% through the “Worst Months.” If you prefer reduced risk and a respectable yield, SHV and SGOV (and similarly constructed ETFs and funds) are reasonable choices to park cash until our next Seasonal Buy Signal later this year.