Guard Swings Back into the Red
Despite a series of warning signs that certain sectors like Utilities and Telecom were overvalued and their summer outperformance was primarily due to yield chasing, investors continued to pile cash into these sectors. Reality Shares has been writing about the risks of owning stocks strictly for their higher yields, and how the prior outperformance of the Utilities and Telecom sectors were not supported by underlying corporate earnings. As these sectors have subsequently experienced slides in momentum and price performance, an underlying but growing hint at some market weakness was signaled by the Reality Shares Guard Indicator, both in these specific sectors and the broader market as a whole.
The Reality Shares Guard Indicator saw the Utilities sector turn negative on November the 2nd, indicating a high likelihood of the sector experiencing correction. The sector rallied from the beginning of the year through July, but subsequently fell over 13% from its peak then, only to experience a short lived bump in later September and put yield chasing investors in harm’s way. Though the utilities sector has rallied over 6.5% year-to-date, price and volatility data suggest that the rally has turned. Dividend investors in these sectors have the potential to experience a dividend cut should earnings decline, amid volatility in the sector.
The Consumer Staples sector, the second sector in the Guard Indicator to turn negative, has also has fallen over 9% from its peak in July. Though as of now the sector manages to remain positive at +0.2% for the year, the Guard Indicator forecasts the possibility of further declines for the sector. If the sector does go negative year-to-date as far as percent change, it would mark just the third sector in the S&P 500 to do so this year.
The Guard Indicator saw the Real Estate sector also turn negative on November 9th. The Real Estate sector is down 5.27% year-to-date, and fell over 15% since its peak in August, reversing the gains made in the rally from February through July.
Most recently, Healthcare was marked negative on November 18th, based on weakness in the sector, and negative forward-looking indicators.
The Guard Indicator was recently updated as the S&P 500 officially recognized the addition of an 11th sector, Real Estate. As a welcome to the Index and Indicator, the sector also recently went negative. In addition, it now looks like Telecom, and Consumer Discretionary could be signaling weakness in the near term. When the Guard Indicator turns negative in three sectors, it indicates the potential for broader market declines—and the Indicator is now pointing that direction.
Source: Bloomberg, Reality Shares Research. Data as of November 18, 2016. Past performance does not guarantee future results.
How the Guard Indicator Works
The Guard Indicator incorporates a quantitative, technical analysis comparing long-term and short-term moving averages inprice momentum and downside deviation of price volatility across the broad market sectors on a daily basis. The Indicator notes when a sector’s long-term and short-term moving averages in the specified criteria intersect.
Guard Scores are calculated for each of the broad market sectors. As each sector’s Guard Score is calculated independently, it is possible to analyze each individually to see inflection points and to predict how they might impact the overall Guard Indicator. A percentage is assigned based on the available data, indicating a particular sector’s likelihood of approaching negative or positive territory. When eight or more of the sectors have a positive Guard Score, the Guard Indicator forecasts a broad market upswing. However, when seven or fewer of the sectors have positive Guard Score, the Guard Indicator points toward possible market weakness.
An analysis of the information across the sectors allows the Guard Indicator to pinpoint potential broad market inflections in both positive and negative directions
Impact on GARD ETF
As of November 18, 2016.
The Reality Shares Guard Indicator is designed as a tool to anticipate broad market downturns. By recognizing broad market rallies through a detailed technical analysis of individual sectors, the Indicator can filter out market and sector noise and concentrate on broader market swings. Though the Guard Indicator may not always capture the shorter-term market movements, the model shows potential in identifying opportunities to exit and re-enter the market.
The Reality Shares GARD ETF incorporates this broad market analysis as part of its dynamic hedging strategy, utilizing it to determine the timing of a short component while using DIVCON to systematically determine individual security selection. Learn More.
S&P 500: A broad stock market index of 500 large companies based on market capitalization. You cannot invest directly in an index. Downside Deviation: The measure of downside risk as calculated by taking the standard deviation of negative volatility.
The models used in the Guard Indicator may be incomplete, flawed or based on inaccurate assumptions.