Is It Time to Play Defense? — Evening Brief – 09.19.24 

The endurance of the U.S. equity rally that began in October 2023 has been called into doubt by recent market volatility. No definitive warning sign has appeared yet, particularly with the strong rally witnessed on Thursday, but there are indications in certain areas of the market that a shift may be about to take place.

Overall, global market conditions remain robust. Utilizing two asset allocation ETFs as a benchmark, the bullish trend has staggered from time to time, but the overall inclination remains favorable.   

The ratio of the iShares Core Aggressive Allocation ETF (AOA) to the iShares Core Conservative Allocation ETF (AOK) has not scathed the recent volatility; however, the 50-day moving average remains significantly above the 200-day moving average, indicating strength in the more aggressive sectors of the market. 

While the ratio provides limited utility for short-term trading, its significance as an initial estimate of the medium-term trend indicates that it is still premature to assert that risk appetites are dwindling. 

For US stocks, however, there appears to be some concern when looking at the trend in the SPDR S&P 500 ETF Trust (SPY) versus the iShares MSCI USA Min Vol Factor ETF (USMV), a low-volatility portfolio of U.S. equities. The 50-day moving average for the SPY:USMV ratio dipped beneath its 200-day moving average on Wednesday — marking the first downtrend signal for these averages since early 2022, which foreshadowed a prolonged decline for U.S. equities. 

There is also a decline in the high-performing sector of semiconductor equities, as indicated by the iShares Semiconductor ETF (SOXX), in comparison to the SPY. Semiconductor stocks frequently serve as an indicator of the business cycle. Additional weakness in this sector may be interpreted as a potential early warning for the economic forecast. 

Recently, the Utilities Select Sector SPDR Fund (XLU), a safe-haven proxy for utility equities, has risen in comparison to the SPY, indicating a departure from a prolonged decline. This shift suggests a transition to a risk-averse sentiment. 

The ratio of the medium-duration iShares 7-10 Year Treasury Bond ETF (IEF) to the shorter-duration iShares 1-3 Year Treasury Bond ETF (SHY) serves as an additional indicator of the possibility of a shift to risk-off given its recent rise. Conversely, although the ratio of SPY to the Vanguard Total Bond Market Index Fund (BND) has gyrated recently, it has not yet indicated a definitive risk-off signal. 

The evidence appears to support a more defensive position in the near future. In the long term, it may be prudent to wait and view the current market volatility as mere noise.