Chart Advisor: Digesting the SPY Drop

By C. Theodore Hicks II, CFP®, CKA®, CMT®

1/ Having Expectations

2/ Equals Knowing How to React

3/ An Opportunity to Add

4/ Check Your Assumptions

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1/ Having Expectations

Earlier this week, I wrote that it would be reasonable to expect a pullback in the markets in the week ahead. Coming into this week, the broad market had been up seven weeks in a row. After a run like that, it is very common to see the market pause and digest the gains.

Yesterday, the market began to do just that. 

Chart 1 shows the 5-minute chart for SPY, an S&P 500 ETF. Because this ETF is very active, my data feed into Optuma (the charting software we use) shows pre and post-market trades. The light blue box represents the 9:30 to 4:00 pm trading hours. 

We can easily see that the market opened and started to gradually move higher. Then, shortly after the lunch hour, the selloff began … and it was precipitous.

However, when we remember the macro view that we developed over the weekend, today’s market action is not surprising.

2/ Equals Knowing How To React

Earlier in the week, I pointed out that the technology sector was the most stretched. In other words, the tech sector was the furthest above its 200-day simple moving average (i.e. ‘stretched’). I made this point to highlight the fact that if my macro view was correct (that we could see a pullback in the week ahead) then the pullback might be the most pronounced in the tech sector since it is the most extended.

What sector was hit the hardest on Wednesday? 

Well, the answer depends on whether you are looking at the cap-weighted sector ETFs or the equal-weighted sector ETFs. Since the equal-weighted sectors gives equal weight to each constituent, this is where I look. 

On Wednesday, out of the 11 equal-weight sector ETFs, the equal-weight tech ETF (shown in Chart 2) was hit the hardest. It was down ~2.03% on the day, the most out of all the 11 ETFs.

Returning to our macro-view, we expected this, so there is no reason to be alarmed. In addition, look at where the ETF closed for the day – right below the 8-day moving average. Again, no surprise here. A side note: I actually do not recall why I use an 8-day moving average. It is a bit of an odd one. If I were to change my chart to a 10-day moving average (which is 2 trading weeks which makes more sense), I’d see that the ETF has a little further to fall to get back in line. 

My main point here is that it is important to set a macro view. If the market responds in line with your view, and you have created a plan based on that macro view, there is no reason to make any adjustments. If, however, the market does something you did not expect, then you might want to consider revisiting your macro view.

3/ An Opportunity to Add

Chart 3 is the weekly chart for the equal-weight tech sector ETF. As stated in one of these newsletters earlier in the week, the vast majority of our clients are either nearing retirement or are already in retirement. As a result, we focus on risk first. If we have shifted our portfolios into a defensive posture, we do not flip back into our most aggressive offensive posture with the flip of a switch. We practice what is called “progressive exposure”.

As a result of what we see underneath the surface of the indices, we have greater confidence that we are at the beginning stages of a bull market.

Since November 1st, practicing “progressive exposure” we have gradually increased our allocation to equities. Therefore, we are viewing today’s selloff as an opportunity to increase our equity exposure at a better price.

4/ Check Your Assumptions

However, a review of a simple comparison chart for the equal-weight sector ETFs since November 1st reveals something that I did not expect. I fully expected RSPT to be at the top of this list. However, it is the equal-weight consumer discretionary sector that tops this chart. 

This is why it is imperative to check your assumptions at the door. Check the data and proceed accordingly.

Acts 17:11

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Originally posted 21st December 2023