Weekly Note - October 25, 2023

This note covers:

  • Current market conditions as indicated by the Market Resilience Indexes (see link for descriptions) and our new Risk Tolerance Drivers (discussed below).
  • Comment about select ETF holdings

The stock market has the following conditions:

  Negative for stock prices -
  • The MRI indicate that the short-term (Micro) and long-term (Macro) trends for stock prices (DJIA) are now negative. The Macro MRI could remain in the downleg of its cycle for several months.
  • Our new risk tolerance drivers (described below) indicate that risk tolerance will decrease over the coming weeks and months, supporting the negative trend indicated by the MRI. Risk tolerance will decrease more dramatically after the end of November. 
  • Stock valuation measures remain high and interest rates are high, which put downward pressure on stock prices, all else equal.

   Positive for stock prices -

  • The potential for a counter-trend rally in stock prices (this condition is causing our algorithms to continue to hold the DJIA- and NASDAQ-linked ETFs). While this is a positive dynamic, it is short-term in nature.
Since the only positive current dynamic is transitory and is not likely to last as long as the negative dynamics, it is prudent to continue to reduce risk in our portfolios by raising Box #2 Cash in advance of what the algorithms indicate. 


The stock market is continuing its recent shift to lower resilience and has established a negative long-term price trend. The Macro MRI and Exceptional Macro MRI ceased indicating a positive price trend a few weeks ago and did so more decisively than has been the case over the last year. The MRI are based on our proprietary measures of index return acceleration and thus are affected by current events and naturally occurring cycles of optimism.  

You may recall from prior notes that the positive long-term trend in stock prices since last September has been weak by historical standards:
  • The Macro MRI, which indicates the long-term trend of stock prices, has moved almost horizontally for about a year. It is more common for it to move more steeply up or down.
  • The Exceptional Macro, which appears when the Macro MRI is likely to develop a more positive slope, has been off and on over the same period. It typically changes status more decisively.
Thus, the price recovery over the last year has been abnormally weak making the recent shift to a more negative trend unsurprising. We are now in a period in which the long-term trend of prices is negative, which is a bear market using our definition.

The Micro MRI, which measures the shortest cycle of resilience is still in the downleg of its cycle. This means that none of the three MRI are providing resilience at this time. In many similar situations, the algorithms would call for zero weight in the DJIA-linked ETFs. The reason they do not do so now is because the Micro MRI is at a very low level, at the 19th percentile of levels since 1918. We can reasonably expect the Micro MRI to reach its trough and then move to the upleg of its cycle over the coming weeks. 

When the Micro MRI does shift to its upleg, the short-term rally will begin. Yet, because the Macro MRI (indicating the long-term trend of prices) is in the downleg of its cycle, the rally will be a counter-trend rally. Such rallies typically end quickly and prices then decline to a level lower than when the rally started. 

The algorithms are expecting this shift and a short-term move higher in stock prices. They suggest we continue to hold the DJIA-linked ETFs. On average over the last 100 years, the algorithms have been successful participating in counter-trend rallies and getting out in time to avoid the major declines. For this reason, the target weights for the DJIA are positive. The weight of these ETFs may increase after the Micro MRI has indeed shifted to the upleg of its cycle. 

The current MRI readings suggest that the counter-trend rally will not be sufficiently strong to change the trend of the Macro MRI to positive from negative. If this continues to be the case increasing our allocation to cash prior to the end of November will be appropriate for reasons discussed below.   

    Risk Tolerance Drivers

Our recent research on the natural cycles of investor optimism has enabled us to forecast what we call collective investor risk tolerance. Investor risk tolerance describes when investors collectively put a positive (high risk tolerance) or negative (low) spin on any events that take place. Our risk tolerance forecasts are based on variables that are independent of and exogenous to the markets. 

In general, the risk tolerance forecasts indicate potential positive and negative inflection points in the MRI that will be realized if there is an economic need for a meaningful adjustment in stock prices. In our analysis of major market declines over the last 100 years, the Market Resilience Indexes give (as you know) advanced notice of most major stock market declines, and the risk tolerance drivers give advanced warning of the important shifts in the MRI. Thus, changes in the risk tolerance drivers typically precede the changes in the MRI. 

Because of the exogenous variables we use, we can forecast risk tolerance further into the future than we can forecast the MRI. Thus, the drivers indicate when investors are likely to put a positive or negative spin on current events, and the MRI say when they have done so and to what degree. 

The current risk tolerance forecasts are:
  • Short-term risk tolerance was forecast to begin decreasing from the end of September (a few weeks ago) through mid December. We have already seen this shift in recent stock price declines. 
  • Long-term risk tolerance is likely to decrease more sharply beginning the end of November.
As discussed in a later section, the stock market is under a relatively heavy economic load because valuations and interest rates are high. These conditions likely constitute an economic need for lower stock prices. We expect the market to continue to respond to shifts in collective investor risk tolerance over the next few months.  

An important finding from our analysis of the risk tolerance drivers over the last 100 years is that, over the recent roughly two-year period (2022 and 2023 to date), the DJIA has followed the long-term (Macro) risk tolerance driver and the Macro MRI far more closely than it has over most other two-year periods. Especially over the last year, the DJIA has essentially ignored the Micro MRI. Should this behavior continue, the approaching upleg of the Micro MRI may have a lower than usual impact on stock prices and make the expected counter-trend rally weaker than normal. In addition, the expected negative shift of the long-term (Macro) risk tolerance driver at the end of November may precipitate a dramatic decline in prices. 

Another important feature of the current environment is that the Macro MRI has shifted to the downleg of its cycle IN ADVNCE of its risk tolerance driver. As mentioned, the risk tolerance driver typically precedes the MRI. But in the current situation, the Macro MRI has already shifted to its downleg, presumably responding to negative market conditions. This pattern also occurred in 2007 and was followed by the dramatic declines of 2008. During that period, the Macro MRI successfully indicated the peak of stock prices and then moved to the downleg of its cycle. During the downleg of the Macro MRI, the DJIA experienced a series of counter-trend rallies. However, the major decline in stock prices occurred just after the long-term (Macro) risk tolerance driver shifted to the downleg of its cycle. If that pattern is applicable today, major declines would occur in late November or December.   

For now, both the MRI and the risk tolerance drivers are now flashing warning signs. Holding Box #2 Cash is prudent at this time. There will be a better time in the future to be aggressive. 

    High Economic Load on the Stock Market

The economic load on the stock market is currently high because of elevated valuation levels and high interest rates. The important ratios of Price-to-Book and Price-to-Sales for the DJIA are high relative to levels since 1997. For both ratios, the current level is at about the 80th percentile of levels since 1997. The same is true for the Price-to-Earnings ratio.

The Price-to-Book and Price-to-Sales ratios at the at prior market bottoms have been meaningfully lower than current levels, as shown in Figure 1 below.

Figure 1 

Other measures that contribute to the high economic load on the stock market are the high Fed Funds rate, high yield on US 10-year Treasury bonds, and the relatively low yield on stocks. The Fed Funds rate is high and has only been higher (since 1997) in 2006 and 2007, just prior to the decline of late 2007 and 2008.  The ratio of the yield of the US 10-year Treasury bond to the dividend yield of the DJIA is high and only exceeded this level during that same 2006 and 2007 period. Since the Fed has vowed to keep rates high to combat inflation, the Fed Funds rate is not likely to reduce rates until inflation is lower (which may be associated with lower economic growth). Our MRI metrics for the yield on the US 10-year bond indicate that it is not yet ready to move lower.  Thus, the economic load on the stock market remains elevated.  

    The Positives for the Stock Market

Supporting high stock prices are high economic growth and the historically low current unemployment rate. The recent quarter showed US GDP growth to be 4.9% (this number reflects the quarterly growth rate on an annualized basis). This is a high rate by historical standards. 

The current reading for the unemployment rate is 3.8% and this is a low level by historical standards. Figure 2 below shows the US unemployment rate from 1948 through the most recent month. The heavy blue horizontal line shows the current level.

Figure 2

The large spike on the right is the COVID period. As you can see, just a few periods had unemployment rates as low as the current rate (2019, early 2000, and the late 1960s).

Another plus for stock prices is that stocks are a good hedge against inflation. Stocks tend to hold their value during inflationary times better than bonds. After the initial shock of high inflation hurts stock prices, stocks often perform well. During the 1970s when inflation was high for several years and the MRI navigated the period well. Especially if there is no increase in the unemployment rate, we are likely to find stock ETFs attractive if inflation persists. 

Another factor that might support high stock prices, at least indirectly, are the wars in Ukraine and the Mideast. The Fed may soften its war on inflation and may cut rates sooner than it otherwise would to avoid supporting these conflicts during an economic recession.

Other Portfolio Holdings

Commodities (e.g., oil, gas, corn, wheat, silver, gold) tend to hold their value during inflationary times. Yet, the MRI for the major commodities indexes indicate lower resilience going forward. Over recent weeks, the Macro MRI has been in the upleg of its cycles and the Exceptional Macro has been present. As of last Friday, the Exceptional Macro ended and the Macro, while still in its upleg, is poised to shift to its downleg. These changes suggest that economic growth may slow. Our commodities ETF “COM” has not been sufficiently resilient for it to receive a higher weight in our portfolios. The recent upward swing of the commodity index has not translated into sufficient positive price trends for the individual commodities COM holds. Thus, we have not held our highest possible allocation to COM. Going forward, the algorithms are more likely to suggest holding a higher weight in COM if inflation remains high and economic growth remains strong, but that set of conditions now appears to be less likely than slowing inflation and slowing economic growth.

Our ETFs linked to US 10-year Treasury bonds (UST and TYD) are still vulnerable to declines. If the economy appears to the Fed to be poised to slip into recession, it may cut interest rates, which will provide resilience to these bond ETFs and we would increase allocations to these ETFs accordingly. Some market commentators are saying it is time to hold more in these investments. The MRI suggest that such a move is premature.

Our Bitcoin ETF (BITO) has moved higher. It has additional upside potential. The Macro MRI is in the upleg of its cycle and the Exceptional Macro appeared on September 29, both of which indicate a positive long-term trend in prices. The current target weight is designed to result in a roughly 5% weight in our accounts considering the allocation to Box #2 Cash. This target weight may increase to accommodate positive price moves.



Weekly Note - September 6, 2023

The figures below compare the current stock market environment to three prior periods through the lens of the MRI. They show that the mild recovery of the DJIA since the price of the DJIA hit its low level about a year ago (September 23, 2022) has been comparatively weak. The weakness of the current period explains why our most aggressive ETFs – the DJIA- and NASDAQ-linked ETFs – have lower weights starting this week.

Our portfolios are likely to remain defensive for a few weeks. The specific element of the algorithms causing this change relates to the market being at a possible transition in its long-term trend – moving from a mildly positive trend to a more negative trend. In addition, I expect resilience to decrease as we move through the end of year, based on the drivers of resilience we have identified over the last few years. We could see more resilience during September, as mentioned in prior notes, but the dynamics described below are, according to the algorithms, taking on greater importance.  

Thus, the defensive shift in the target weights driven by the algorithms is not unexpected and it is even welcome. It is why I have indicated to those currently intending to move money into investment accounts to move money in gradually over time. Thus, I am currently cautious about the stock market even if the economy is strong and inflation has declined meaningfully over the last year.

Figure 1 below shows the price of the DJIA (on a log scale) centered around the low price it experienced on September 23, 2022, which was roughly a year ago. It is difficult to draw conclusions from the one line on Figure 1 but I show it to clearly identify the current period; the line is red.

Figure 1

Figure 2 shows three other market declines that have similar characteristics in terms of when they take place in broader market cycles. The purple line shows the period with a low trough in 1958, the blue shows 1970, and the green shows 1982. The lowest price of these periods is aligned to the low point of the current period, at week number 520 (roughly a year ago).

Figure 2

The current period’s rebound from the low price last September has been less dramatic than the others shown. The same message is seen by looking at just the Macro MRI for the different periods, shown in Figure 3.

Figure 3

The Macro MRI normalizes the index’s price movement and shows the trend more clearly. We can see in Figure 3 that the inflection point at the time of the lowest price (September 23, 2022 for the current period) is not as pronounced as it was for the other periods. The macro MRI has been slower to move the upleg of its cycle and its current slope is shallower than the others. These characteristics underscore the tentative nature of the price recovery for the DJIA.  

Periods like the others listed make the best Plant seasons and a good time to switch to a more aggressive model portfolio. Unfortunately, the current period did not have a strong inflection point last September.

We can see the weakness of this recovery in how the Exceptional Macro has behaved since the low in September of last year. Figure 4 shows the Macro and Exceptional Macro for same four periods. As you may recall, the Exceptional Macro is designed to be an alert for when a strong upleg in the market is likely to take place.

Figure 4

You can see in Figure 4 that for the other three periods, the Exceptional Macro appeared and (after a false signal for 1983 in green and 1970 in blue) remained present for many weeks (roughly a year). During the current period, the Exceptional Macro has appeared intermittently. This can be more clearly seen in Figure 5.

Figure 5

Although difficult to see in Figure 5, the Exceptional Macro ended in the last two weeks. This is usually a negative for stock prices. The algorithms have responded to this and other indicators of weakness and reduced the target weights of DJIA-linked ETFs.

Since the beginning of the year, the main algorithms that determine the weight of the DJIA-linked ETFs have navigated this situation reasonably well; they have produced positive returns. But the strength of the DJIA recovery has not been sufficient to justify to switch to a more aggressive portfolio as would have been the case in the other periods shown above.

The weekly publications are designed to allow us to switch easily to more aggressive portfolios when the market begins the upleg of its cycle in a more definitive way. The timing of the switch is a subjective call on my part and is heavily influenced by the information presented above. Over the last year, the recovery has not been as strong as is typically the case.

Because it has not been prudent to switch to a more aggressive portfolio, the portfolio we use has been moderately defensive and therefore has a higher allocation to traditionally more defensive ETFs such as XLP (consumer staples companies), XLU (utilities) and those linked to the US 10year bond index (ETFs UST and TYD). However, the utilities and 10-year bond ETFs have been hit hard by rising inflation and have hurt portfolio performance.

Should the market decline more abruptly over the next few months, the defensive ETFs may be useful. The Fed may lower interest rates as the markets and economy soften and our defensive stock ETFs (XLU, XLP) and the 10-year bond ETFs (UST, TYD) will be supported by that shift. Thus, the composition of our current portfolios is reasonable. Should the stock market enter a stronger, more resilient phase we will switch to a more aggressive portfolio. I do have waiting in the wings a set of portfolios that will be effective in a robust market recovery accompanied by persistently high interest rates (they hold minimal weights in the defensive ETFs) and will introduce them later if needed.


Weekly Note - June 14, 2023

Sections in this post:

A. Confusing Time
B. This Type of Divergence is Expected and Why We Focus on the DJIA
C. The Spread Between Leading and Lagging Sectors is High
D. Not Yet a Bull Market for the DJIA
E. High Stock Valuations
F. Corporate Earnings Have Not Yet Declined
G. A Period of Low Investor Excitability Has Just Ended
H. But There is Progress Toward Stronger Markets


A. Confusing Time 

This is a confusing time in the markets. A recent headline declared the end of the declines in the stock market…

“The bear market in stocks has officially ended and a new bull market has kicked off. Here's why investors can expect more gains ahead.” (LINK) 

        By Matthew Fox Fri, June 9, 2023 at 3:13 PM PDT·

The longest bear market since 1948 is officially over after the S&P 500 closed above 4,292 on Thursday, representing a 20% rally from its October 12 closing low of 3,577.

The threshold was reached on the back of better-than-feared corporate earnings, a resilient economy and job market, and the expectation that the Federal Reserve is about to pause its aggressive cycle of hiking interest rates.

Yet not all parts of the stock market have received the news. While the tech-biased NASDAQ stock index is moving higher quickly (likely sparked by the AI theme) with year-to-date performance through last Friday (June 9) of 33%, the DJIA has lagged. It has had a return of 3% over the same period. The technology sector of the economy and stock market is currently a breakaway sector. I explain why the DJIA and NASDAQ have had such different performance and why we should be okay with this difference, even if it is painful.

But the key points for you as an investor are:

  • Be patient with recent performance - it has been lackluster this year for most of the stock market.
    • Do not switch portfolios to try to get higher returns
    • The difference between top performing ETFs (leading) and bottom performing ETFs (lagging) is large by historical standards in normal times. If one chases performance and switches to a portfolio or ETF that has recently been leading one runs the risk of selling ETFs that will be lead in the future and buying ETFs that will lag.
  • Be cautious of what the business press says. Many have said the bear market is over. It seems to be over for the tech sector and the NASDAQ, but it not quite over for the rest of the economy and stock market outside of technology. 

B. This Type of Divergence is Expected and Why We Focus on the DJIA

This type of situation is exactly why we focus our portfolio on the DJIA and not on what we in the investment industry call “market-capitalization weighted” indexes, such as the Russell 1000 (consisting of 1000 companies) and the S&P 500 (consisting of 500 companies). These market capitalization-weighted indexes seek to invest in all major companies in an economy and in all its economic sectors (Energy, Consumer Staples, Utilities, Technology, etc.). The weight of each company in the index is determined by price of its stock and the number of stock shares it has in the marketplace. The higher the price goes the more weight it is given in the index. These indexes have advantages if you are investing billions of dollars.

This type of index also works fine for individual investors when stock price appreciation is spread evenly across all economic sectors, but it can cause trouble when one sector experiences abnormally high price gains; when it becomes a breakaway sector. If the companies in one sector do better than companies in other sectors, that sector is weighted more heavily in the index.

Two sectors that have tended to be breakaway sectors in the past are technology and energy. The technology sector became a breakaway sector in the late 1990s with the Internet/Dotcom boom. Energy was a break away sector in the 1970s and 1980s.

As the breakaway the sector did better it got a higher weight in broad stock market indexes such as the S&P500.  And it got to its highest weight in the index at the very peak of its performance cycle. 

This happened to the tech sector in early 2000, just before the technology bubble collapsed. As individual investors, we do not want that. We would like to have less weight in a breakaway sector at the peak of its performance cycle.

In contrast, the DJIA focuses on 30 companies and does not seek to have full representation of every sector in the economy. The weights of individual companies and sector weights do not change as dramatically over time as they do in market-capitalization weighted indexes. This is because it selects just a few high-quality companies for inclusion and uses an archaic weighting scheme. The result is greater consistency in the weighting of the 30 companies. The net effect is that it is less prone to give the highest weight to an individual company or a sector at the top of its performance cycle. 

The link to our ETF holdings page (https://marketresilience.blogspot.com/p/etf-holdings.html) shows the weight of stocks in the DJIA and NASDAQ-100.  You can see that the largest holdings in the DJIA are smaller than the largest holdings in the NASDAQ – a market-capitalization weighted index. That means the DJIA is less concentrated in a few specific companies. 

In our early research on stock indexes, we found that the DJIA gives more reliable signals indicating its future direction than do the S&P500 or Russell 1000. We believe the small number of high-quality companies it holds (30) and its archaic weighting scheme contribute to its reliability. Thus, in addition to the advantage of its long history, we found its signal reliability very attractive, and the DJIA is our core stock index.

We also find it is better to make decisions about the technology and energy sectors of the stock market separately from the rest of the economy; they follow their own independent cycles and series of inflection points. 

At this time, technology is a breakaway sector. NASDAQ has a roughly 58% weight in companies in the technology sector, with the S&P500 having 28% in tech. The DJIA has an 18% weight in the sector. While the NASDAQ and to an extent the S&P500 rocket higher with tech, the DJIA and other sectors are still on the ground. The other sectors of the economy are is contending with concerns about slower growth brought on by higher interest rates, inflation, and a possible recession. 

The impact of tech on the S&P is discussed in an article I've posted over the last few weeks: https://www.axios.com/2023/06/01/sp500-tech-companies-stock-price.

The strength of the current stock market in the technology sector may be influenced by the hype about ChatGPT and AI. Should they fail to live up to the hype (which is likely) the tech sector may experience a meaningful decline. It could then drag down the indexes, such as the NASDAQ and S&P500, that have high weights in the tech sector. We may find that the press article I mentioned at the beginning of this post is not as strong as it currently seems.   

C. The Spread Between Leading and Lagging Sectors is High

Our stock ETFs tend to have low exposure to technology and have lagged the technology sector. The conservative stock ETFs of XLP (consumer staples companies) and XLU (utility companies) have performed poorly.  These lagging indexes are fighting the battles with inflation and a possible recession (although the threat seems to be receding).

The important concept right now is that the spread between leading and lagging indexes/ETFs is high by recent standards. Figure 1 below shows the monthly returns of the stock ETFs we hold. The cluster at the far right in the ellipse shows the returns for May 2023.

  • DJIA:             -3% in May 2023
  • Cons Staples: -6%
  • Utilities:          -6%
  • NASDAQ:          8%

Figure 1

Over the 18 months shown above, all indexes/ETFs had positive returns in half the months except Consumer Staples (XLP), which had slightly fewer (8 out of the 18 months were positive). 

The turquoise bar in Figure 1 above indicates the difference, or spread, between the top, “Max,” performing index (NASDAQ at 8%) and the bottom, “Min,” performing (Consumer Staples at -6%) for May, which is 14 percentage points.  Over the months shown in Figure 1, we can see that the level of 14% is the second highest of the period. In March of 2022, the difference was 16%. Over the 18-month period shown, NASDAQ, shown as the purple bar, is sometimes very positive and sometimes very negative, which reflects the boom-and-bust pattern we see in technology stocks. 

For clarity, Figure 2 below shows only the Max-Min line over the same period. It shows 14% for May.

Figure 2

You can see more clearly that the recent spread between the top and bottom performing ETF in May was indeed among the highest. 

Figure 3 below shows the monthly Max-Min line over a longer timeframe, going back to January of 1990.  A key point is that the current high level of about 15% is quite high by historical standards except for the Internet boom and bust that ran from about 1997 to 2003.  

Figure 3

From this perspective, the current outperformance of NASDAQ may be at the extreme and it may be reversed over the near future. To invest heavily in NASDAQ now may risk investing in it just as it begins to underperform the others. The Micro MRI for the NASDAQ was at the 87th percentile last Friday - a high level. Thus, we will move into NASDAQ opportunistically. 

There have been several periods over the last 100+ years in which there have been large spreads between the DJIA and breakaway sectors such as technology and energy. Even considering these periods, the historical simulations indicate that our strategy can produce high return and low variability.  

D. Not Yet a Bull Market for the DJIA

Figure 4 below indicates the status of the Macro MRI for key indexes. This first column indicates whether the Macro MRI is now in the upleg of its cycle. The second indicates the Macro’s level (percentile) compared to its own history. Third, whether the Exceptional Macro is present. Fourth, whether the index could be described as being in a bull market as indicated by the Macro MRI being in the upleg of its cycle and the presence of the Exceptional Macro. The inception date of the index.

Figure 4

Historically, bull markets are most reliably indicated by the DJIA. Thus, that the DJIA has not made a full shift is worth noting. It is best to follow our discipline which is to pay most attention to the DJIA, which suggest caution at this time. 

The current status is somewhat troubling because the physics-based drivers we’ve recently developed indicate that the Macro MRI had an opportunity to begin its upleg last September. The NASDAQ seems to have responded to that driver, but the DJIA has not.

For the DJIA, the beginning of the Macro’s upleg was late and the Exceptional Macro made sporadic appearances, which is not at all typical. Looking back over the last 100 years, the Macro MRI has been more responsive to the driver. We suspect that the lack of major declines in stocks over the last 18 months has allowed high stock valuations to persist, and that this is a major factor in the lackluster stock returns outside of the tech sector. The DJIA seems to suggest there is unfinished business from the last year and a half.  

E. High Stock Valuations

Figure 5 below shows that the current valuations levels are still high for the DJIA. When valuations are high, stock prices tend to move lower. When valuations are low, stock prices tend to move higher. This is a version of buy low and sell high.

The important Price/Book and Price/Sales ratios for the DJIA are still high by historical standards, at the 83rd and 88th percentile, respectively. This is a high level compared to the historical refence points (A, B, and C) shown that are the low points of the DJIA price levels (after large declines), just before a bull market begins.  

Figure 5

It appears that investors in general have not been concerned by these high levels. The same is true for companies in NASDAQ. Figure 6 below shows the same table for the NASDAQ 100. 

Figure 6

The important Price/Book and Price/Sales ratios are still high by historical standards, at the 91rd percentiles for both. This is a high level compared to the historical refence points (A, B, C, and D) shown that are the low points of the NASDAQ price levels (after large declines) just as a bull market begins. 

F. Corporate Earnings Have Not Yet Declined

By some measures, corporate earnings have not yet shown the declines that might be expected after a bear market. Figure 7 below shows the DJIA (brown line, log scale) and our measure of “Economic Load” (orange) on the stock market. Economic Load is our composite of valuation statistics, change in short-term interest rates, and a comparison of stock dividend yield to bond yields.  The higher the orange line, the more downward pressure there is on stock prices and corporate earnings (double blue line).  

Figure 7




After the major peaks in the economic load in 2007 (C) during the Global Financial Crisis, the DJIA and corporate earnings declined meaningfully. The same is true after B although that decline was affected by the COVID pandemic. It appears that the current situation (A) is different. The anticipated declines have not yet occurred. Perhaps they won’t, but it is too early to conclude they won’t because the declines in stock prices and corporate earnings occurred well after the peaks of the economic load at C and B. 

G. A Period of Low Investor Excitability Has Just Ended

This lack of concern about valuations economic load could be related to the period of low investor excitability we have just passed through. At the beginning of 2022, we indicated that the next several months could be expected to have muted price cycles – an indication that investors will not get excited about either good news or bad news. This view is based on our recent research on the drivers of resilience. That same research suggests that the calm is over and that investors will now be much more excited about both good news and bad news. We may find that investors will now be more concerned about valuations and favor lower prices for stocks. If true, the reliability and the current conservative nature of the DJIA will be to our advantage. 

H. But There is Progress Toward Stronger Markets

I do think we have begun a new long-term trend toward higher stock prices. The stock market has been battling headwinds since the end of 2017, and this has been a very challenging period.  But that period appears to be over. The Macro MRI for most all stock indexes are at low levels and moving higher.  There will still be challenges but instead of headwinds fighting our progress, we are likely to have tailwinds the help us along as we work through the short-term challenges presented by the markets. 



Weekly Note - May 31, 2023

The markets continue to vacillate among three paths forward:
  • pricing for a recession (supports higher Treasury bond prices, all else equal)
  • pricing for inflation (weaken support for bonds and DJIA stocks short term, supports higher commodity prices and growth stocks)
  • pricing for stronger economic growth (supports higher stock prices)  

The MRI for the DJIA indicate that while longer-term (Macro) resilience continues to be present, it is fading. The short-term (Micro) resilience cycle is in its downleg but has far to go before reaching the bottom of that cycle; it is at the 60th percentile of levels since 1918. The Exceptional Macro, which could compensate for the Micro MRI being in its downleg, is no longer present. This mix suggests a moderately high level of vulnerability for DJIA prices. The algorithms continue to have low target weights for stocks.  

Some of the recent changes in the MRI might be related to the debt ceiling negotiations in Washington. The strength of the longer-term (Macro) resilience was not high prior to the negotiations possibly due to existing concerns about an impending recession and high stock valuations. The debates may have added to those concerns. The drivers of resilience that we recently developed suggest that stock market resilience should be stronger than it has been recently, which supports the idea that stock market investors are becoming more concerned about these issues.

If recession does indeed become the dominant issue, our bond investments can provide a good source of return in our portfolios.

Should the market start pricing for stronger economic growth and lower inflation, our current stock and bond investments can perform well. The MRI have recently suggested that this was a plausible scenario. Support for this path can be seen in the low unemployment rate and lower recent inflation readings.

Should the market start pricing for stronger growth and persistently high inflation, we will need to resume investments in a commodities ETF. I discuss the addition of a different commodities ETF in the section below. The upcoming addition of ETF COM is intended to address the long-recognized shortcomings of many of the dominant commodities ETFs.

During a period of stronger growth and persistently high inflation, portfolio performance will also be helped by the addition of a NASDAQ-linked ETF to gain greater exposure to the stocks of higher growth companies. A NASDAQ-linked ETF has not been included in our portfolios thus far because of the tendency during the early 2000s for high growth companies to experience bubble conditions that are difficult to navigate using the MRI. However, our algorithms navigated the recent decline in the NASDAQ well and NASDAQ-linked ETFs will be a good complement to our DJIA-linked ETFs. We do not envision the NASDAQ ETFs replacing the DJIA ETFs.

The portfolios currently hold a high number of ETFs to provide exposure to different asset classes but this is temporary. A lower number makes trading easier. To address this issue, I have indicated that BITO and SHY (cash-like bonds) are optional holdings. If you find it difficult to trade the current portfolio, you can simply not own these and hold that money as cash in your account.


We will be adding NASDAQ-linked ETFs to the portfolios in the coming weeks but are likely to start at a very low weight. Our signals indicated that early April 2023 was a good time to buy the NASDAQ-linked ETFs. Unfortunately, we did not respond by adding NASDAQ at that time and have missed the strong returns since then. To date, this has been a mistake. While NASDAQ is a good long-term addition to the portfolios, this may not be a good time to give it a meaningful weight in the portfolio because its Micro MRI is currently very high in its cycle. Thus, it will likely have a small weight in the portfolios until a better buying opportunity occurs. Figure 1 below shows DJIA and NASDAQ performance for the recent twelve months.

Figure 1

The recent 12 months are shown along the horizontal axis. You can see that the performance of NASDAQ has been quite strong in May. The three MRI (Micro, Macro and Exceptional Macro) for NASDAQ have all been positive and providing resilience over the last few months. The move higher is likely the result of those forces plus the excitement about AI and its business potential for major tech companies.

Figure 2 below shows how our algorithms have timed exposure to NASDAQ. Figure 2 shows a 2x leveraged ETF (QLD) if bought and held over time (red line, labelled “Policy Weights”) and if bought and sold to avoid losses (gold line, which is called the traded sleeve) with the money invested in bonds when not in QLD.

Figure 2

In the early 2000s, the losses of the traded sleeve (gold) are less than simply holding the ETF (red), but were still too high for the ETF to be a good addition to our portfolios.

However, the traded sleeve (gold) avoided the worst losses since 2021 and indicates that our algorithms work effectively. Their greater effectiveness may be primarily the result of the maturing of the companies in the index - the NASDAQ of today is different than the NASDAQ of the early 2000s. The largest holdings of the NASDAQ ETFs are currently Microsoft, Apple, NVIDIA, Amazon, and Google – clearly major companies. While I do not have access to the names of the companies representing the largest holdings in 2000, the major companies of NASDAQ did not have the similar global stature and existing businesses of those dominating NASDAQ today.

A figure showing trades for the ETF QQQ (no leverage) and TQQQ (3x leverage) would show a similar pattern relative to holding the respective ETFs long term without trading.

Adding ETF COM for Commodities Exposure

An investment in commodities can provide positive returns during inflationary periods. I have been following commodities since the mid-2000s and the track record of the algorithms since that time has been good relative to the main commodities index, which is tracked by the ETF GSG. Figure 3 below shows the commodities ETF GSG without trading to avoid losses (red line, labelled “Policy Weights”). It also shows the return of using our algorithms to avoid losses (gold line, labelled “Sleeve”). I started running these signals in real life at the time indicated by vertical green line (July 2008).

Figure 3

The traded sleeve (gold) has far better performance than holding GSG long term (red). Yet, the performance of the traded sleeve (gold) is still too volatile for our purposes. The losses in 2020 and 2022 were dramatic.

A long-standing problem with most commodity ETFs (including GSG and PBDC, both of which we have used) is that they are heavily biased toward energy commodities (such as oil and gas). They currently hold about 60% of their assets in energy commodities. Energy commodities have had a large impact on inflation so this makes sense. But in general, we avoid investing in assets that are heavily influenced by the decisions of small group of people. Energy prices have been heavily influenced by OPEC decisions and government policy. This aspect of the major commodity ETFs plus the normal volatility of energy prices has always made commodities an uncomfortable addition to our portfolios.

Furthermore, there are commodities other than oil and gas that perform well during times of inflation, such as industrial metals (e.g., copper and aluminum), precious metals (gold and silver), and agricultural (wheat, cattle). Gold can be an important commodity in times of stress so we have used a gold ETF to get the needed exposure.

The ETF COM is different than SGS and PDBC. It does not hold static exposures to commodities. Instead, it tracks a rules-based index that began in October of 2010 that invests in a range of commodities. When a commodity exhibits a positive price trend for a specified period of time, the index increases the weight of that commodity. It will invest in up to 12 commodities (through futures contracts). The index has a simulated track record prior to 2010, which we have evaluated.

Figure 4 below shows three commodity ETFs, GSG (one of the largest and oldest), PDBC (which we have used most recently), and COM (which we plan on adding). The time period is May 2015 (the inception of PDBC) through May 31, 2023.

Figure 4

All three ETFs provided exposure to commodities during the sharp move higher (blue arrow) beginning in 2020 and ending in early 2022, which is a good characteristic for our portfolios. But COM (black) does not have the sharp declines seen in the other ETFs, which is an added benefit.

In our evaluation of COM, we found our long-term (Macro) MRI has done a good job of smoothing out the returns even further. Figure 5 below shows the performance of COM (red), and trading using the models we developed for it (gold line). This analysis was done recently so is not as objective as that shown for the GSG in Figure 3, but the figure below does suggest that COM has a regular cycle of resilience that we can use to smooth returns.

Figure 5

During the long period in which there were small positive returns (2011 through 2016) we would not have a meaningful target weight for ETF COM. We plan on using it tactically when positive returns are expected. Our current reading for COM is to have a target weight of zero but that positive returns may develop in the foreseeable future. Thus, adding this ETF over the next few weeks makes sense.



Weekly Note - April 12, 2023


The current MRI dynamics of the DJIA and the US Treasury bond indexes suggest that both stocks and bonds will move higher from here. Over the next few weeks, we are likely to see greater resilience emanating from natural sources as indicated by the drivers mentioned below. That said, the current weakness of the Exceptional Macro for the DJIA, high stock valuations, and the upcoming period of high investor excitability beginning in early June (at the latest) are the main focus of our attention for the coming several weeks.

Note: For the next several weeks, we will be holding more ETFs than usual. Over the next month or two, we will identify redundant ETFs and remove them to make trading easier. The research on the drivers has resulted in lower trading, which has made a higher number of ETFs in the portfolios more acceptable for the time being.

The Status of the Stock and Bond Markets

Please see this page for descriptions of the language used to discuss our Market Resilience Indexes® https://focused15investing.com/language

Since the end of 2021, the stock and bond markets have faced significant challenges. These include a persistent war, inflationary pressures, central bank actions to combat inflation by raising interest rates, and concerns about a possible recession caused by higher interest rates. The Federal Funds rate increased to 4.83% from a low of 0.06% in June of 2021.

Despite these challenges, the decline in the DJIA has been minimal, declining only 1% since the beginning of January 2021 through last Friday (April 7). Plus, stock valuations have remained high for the last 18 months (see this page for current valuation levels: https://marketresilience.blogspot.com/p/djia-historical-valuation-comparison.html. Many market commentators have wondered why stock investors have not sold their stocks in a panic similar to those seen in March 2020 (Covid) and 2008 (Global Financial Crisis).

From our perspective, the answer may lie in the physics-based drivers of resilience that give rise to the market fluctuations we track with the MRI. At the end of 2021, we determined that the next 12 to 18 months would be a period of low investor excitability. Market gains and losses are muted during such periods. The declines of 2008 and 2020 occurred during periods of high investor excitability, as did most of the major stock market gains and losses of the last 100 years.

The current low level of investor excitability has, we believe, resulted in the absence of significant declines in stock prices over the last 15 months. However, we anticipate that this period of low investor excitability will come to an end by the end of May, based on objective non-market drivers of investor risk aversion. After that time, we are more likely to see investor euphoria and panic and larger price swings higher or lower.

Unfortunately, it is unclear at this time whether the dramatic moves will be higher or lower. Investors may attempt to correct the currently high stock valuations by selling stocks and driving down their prices. Or they may favor stocks due to the expectation of lower future interest rates and a positive trajectory for both stocks and bonds. Based on our analysis of current conditions, the expected shift is currently toward greater in investor risk tolerance and market resilience. 

The sections below show the current MRI conditions of key stock and bond markets, which will show the generally positive trajectory for both stocks and bonds. We update our view of conditions each week and will respond as needed.   

The DJIA Over the Last 15 Months

As a way of describing the dynamics of the last 15 months, I will first show the price of the DJIA (log scale) and its Macro, Exceptional Macro, and Micro MRI. Figure 1 below shows the period from December 1, 2020 through last Friday (April 7, 2023). The upper line is the DJIA, with a vertical line on April 7, 2023 in order to highlight the current date. The scale is not shown; the important patterns to see are the relative movements of the DJIA. 

The smooth blue line is the Macro MRI. It peaked in December of 2021 (at the 80th percentile of levels since 1918), indicated by the red arrow.  It has been in the downleg of its cycle until last week when it shifted to the upleg of its cycle (at the 27th percentile), indicated by the green arrow. If we were just making investment decisions based on the Macro MRI, we would have sold the DJIA-linked ETFs in December 2021 and we would be buying now.   

Figure 1

However, our disciplines call for also considering the presence of the Exceptional Macro MRI and the cycles of the Micro MRI. 

The small vertical arrows show the presence of the Exceptional Macro. It was present from the beginning of the period shown to July of 2021 (a), and a short period in December of 2022 and early 2023 (b). It appeared again two weeks ago. 

The Exceptional Macro appears when the Macro MRI begins to shift from the downleg of its cycle to the upleg, although there are false signals from time to time. In many cases, when Exceptional Macro is present, the stock market is highly resilient and can overwhelm any vulnerability indicated by the Micro MRI. 

In the current situation the Exceptional Macro is not as strong as it normally is after major stock price declines. This condition could be rooted in the fact that we have not had a major (e.g., a loss greater than 30%) decline in the DJIA thus far.

The purple line shows the Micro MRI for the DJIA, which tracks its shortest cycle of resilience.  One can see that the DJIA price movements parallel the Micro MRI except when the Exceptional Macro is present. As expected, the Exceptional Macro overwhelms any lack of resilience stemming from the declining Micro MRI.  From this perspective, the market has performed as expected given the MRI conditions. 

These dynamics suggest that the market will be more resilient for the next several weeks and possibly months:

  • The Macro MRI for the DJIA is currently at a low level by historical norms (at the 27th percentile of levels since 1918), and has declined dramatically from the 80th percentile at its recent peak shown by the red arrow indicating the end of 2021,
  • The Macro MRI has shifted to the upleg of its cycle as of the last week
  • The last three times the DJIA’s Macro MRI troughed at this level (12/2020, 6/2016, and 9/1988) were followed 6 months later by returns of 15%, 10%, and 12%, respectively. In addition, the DJIA continued to move higher after the six-month period in each of these cases.
  • The Exceptional Macro is present.
  • The Micro MRI is a low level (34th percentile since 1918) in its normal range and is in the upleg of its cycle. 

Consistent with these MRI dynamics, the algorithms and computer model evaluating this current status are inching closer to triggering a signal to buy our DJIA-linked ETFs. However, the strength of the Exceptional Marco is not as strong as it typically is at the end of the major stock market declines of the last 100 years. We are watching closely to see the persistence of the Exceptional Macro. It has appeared sporadically over the last several months and there is a small but meaningful chance that it ceases to be present over the next several weeks. If it ceases to be present, we will reduce our exposure to the riskiest ETFs. Yet, for reasons described below it seems that there is a good chance the resilience of the stock and bond markets will follow historical norms and increase from this point. 

As you may recall from prior notes, we have identified likely drivers of the MRI.  These drivers are based on objective variables that are exogenous to the markets and affect the collective risk aversion of investors. The key advantage of these drivers is that they can be forecast into the future giving an indication of future stock market resilience. 

Figure 2 below shows the same period as the prior figure but includes up-arrows indicating the presence of the drivers. The small green up-arrows indicate the short-term driver and the larger blue up-arrows indicate the long-term driver.  The short-term driver generally corresponds to the Micro MRI and the long-term generally corresponds to the Macro MRI. 

Figure 2 

As you can see in the Figure 2 above, the end of the long-term driver and the short-term driver in late 2021 correspond to the red arrow indicating the peak of the Macro MRI. The beginning of the long-term driver in approximately 8-5-2022 corresponded to a shift in DJIA (upper line) after which the DJIA moved more horizontally. 

Conceptually, the effects of these drivers are additive and the long-term driver is stronger. When there are both green and blue arrows, we can expect investors to be more optimistic and the markets to be more resilient. 

Figure 3 below is the same as prior figures with the addition of diagonal arrows during periods when both the short- and long-term drivers are present. During these periods the DJIA avoided major declines and tended to move higher. 

Figure 3

Again, the advantage to understanding the drivers is that we can get a sense for the resilience dynamics of the coming months. You can see that after the vertical line indicating last Friday, we will be entering a period during which the short- and long-term drivers both indicate the potential for higher stock market resilience. At this time, the MRI and the drivers are in agreement: the DJIA is poised to become more resilient.

Subjectively, it appears that simply following the drivers might have been appropriate over the last 15 months; the MRI seemed to follow the drivers. However, following the MRI is typically more successful than following the drivers.

An example of this is the last time we had a major rate increases to fight inflation. The period from early 1981 through mid-1983 is similar to the current period. The period encompasses when Federal Reserve Chairman Paul Volker increased the Federal Funds rate to 20% from 11.2% in June 1981. The period also occurred during a period of low investor excitability. Figure 4 below shows the DJIA from December 1980 through April 1983 with the same markings used in the figures above. Volker increased rates at the point marked by letter A. That event coincidentally occurred at the end of the long-term driver (blue up-arrows), and occurred just before the peak in the Macro MRI, indicated by the red arrow.

Figure 4

The magnitude of the decline in the Macro MRI between the red arrow indicating the peak and the deep green arrow indicting the trough is coincidentally the same magnitude of the decline in the Macro MRI in the recent 15-month period. The change in the Macro MRI suggests that the market response to the recent rate hikes has been as aggressive as it was to the Volker rate hikes decades earlier. 

Subjectively, it appears that from the red arrow to the end of the period shown in Figure 4, the DJIA appears to follow the MRI as opposed to the drivers; the drivers were less explanatory of the change in the DJIA price. This is confirmed by a statistical analysis we performed using the drivers and data from the Daily News Sentiment Index produced by the US Federal Reserve Bank of San Francisco. The conclusions from this analysis are:

  • During the Volker period, the Daily News Sentiment Index explained a high level (77%) of the variations on the DJIA. The MRI capture the effects of news sentiment. The drivers explained a far lower level (23%).
  • During the recent period, the drivers explained a higher level (55%) of the variation in the DJIA. The Daily News Sentiment Index explained less (45%).

While the periods were similar in that they both were affected by large hikes in interest rates to combat inflation and occurred during periods of low investor excitability, the rate change in June of 1981 came after a decade of high interest rates and was more extreme in terms of a rate change. Also, a 20% short-term interest rate is conceivably more economically traumatic and newsworthy than a 4.8% rate. Perhaps the market consensus after the initial shock of inflation and rate increases is that the current period is less traumatic and will pass more quickly.

The less traumatic nature of the recent period is supported by the performance of the DJIA in both periods. Figure 5 below shows the price level of the DJIA in the two periods when interest rates increased dramatically. From the peak in the DJIA through the lowest point in the DJIA for the most recent period (red line) is at week 39, the two paths are similar.  After that point, the declines for the 1981 period continued while there has been a rebound in the recent period.  

Figure 5

The greatest loss for the two periods is similar, at a loss of 23% for the Volker period and a loss of 21% for the current period. In addition, we are 67 weeks into the current decline and the Macro MRI is shifting to its upleg. That is a similar time frame for the Volker period, which ended after 69 weeks.

US Treasury Bonds

During most periods over the last 100 years, bonds have tended tend to move higher when stocks move lower. It is this relationship the makes a portfolio that mixes stocks and bonds attractive. However, in times of rising interest rates that are likely to induce lower economic growth (like the Volker and the current periods), bonds and stocks may drop at the same time. 

Our least aggressive bond ETF is SHY, which is linked to a 1- to 3-year US Treasury bond index. Figure 6 below shows in the upper panel the performance (on a log scale) of a 2-year US Treasury bond index, which is a useful proxy for SHY. The period shown is since January of 2000 through last Friday. In the lower panel is the Macro MRI. The vertical green lines in both panels are the Exceptional Macro MRI. 

Figure 6

You can see that over most of the time period shown, the index in the upper panel moves higher, which indicates a positive return for the index. The index moved higher even in many cases when the Macro MRI moved lower. This is because of the yield on the bonds and has meant that this index and the related ETFs are good investments in most market environments. This behavior makes SHY a good default investment when other ETFs lack resilience. 

In most periods covered in Figure 6, the appearance of the Exceptional Macro indicated the beginning of a period of higher resilience and returns. In the lower panel, the appearance of the Exceptional Macro indicated a likely beginning of the Macro MRI moving higher, as expected. Recently, the Macro MRI peaked recently at the red arrow in the lower panel. The red arrow is also shown in the upper panel.  It was clear at this time that interest rates would be rising to fight inflation and this made SHY unattractive as a default investment. It made sense during this period to use higher Box #2 Cash levels as a default investment. 

The important observation in Figure 6 above is that the Macro MRI has recently begun the upleg of its cycle and has done so at a low level (green arrow).  The Macro MRI is currently at the 1st percentile of levels since the beginning of the index in 1980 – an extremely low level. We now expect SHY to function more normally as a default investment and we have taken Box #2 Cash down to a normal level. 

A similar pattern is seen for the 10-year US Treasury bond index that is a good proxy for our more aggressive bond ETFs (UST and TYD), as seen in Figure 7 below. At the end of 2020 shown by the red arrow below, the Macro MRI was at the 100th percentile since the beginning of the index in 1983. It declined to a percentile of lower than the 1st percentile at the time shown by the deep green arrow. 

Figure 7

Based on analysis of yields for the 10-year bonds (which has a longer history), the magnitude of change in Macro levels shown above would be equally extreme over the period since 1962.  The current level of the Macro MRI would be similar to the levels in the fall of 1963, early 1970, late 1966, and late 1981. These are all time times after which bonds produced high returns.