Can The S&P 500 11-Sector Diffusion Index Fulfill?

Introduction

“The Sector Diffusion Index (SDI)

The Trifecta Distribution Index [TDI] has lucidly reached readers. The quite positive response encourages me to explore capturing the rotation trend of 11 Sectors of SPY, comparing other equal weighted ETFs, Russell 2000 ETF, and mid-cap ETFs.

I have worked with Diffusion Index at the CIBCR during the 1980s, and 11 years ago, I published my first article in 2011. At that time, every day, I posted my TANER (which stands for "Topping, Advancing, Neutral, Ending, and Reversing.") TANER has several Diffusion Indexes with 40 stocks, 40 short-term bonds, Vanguard ETFs, and so on. Many investors followed my TANER.

Last weekend I extracted 11 Sectors of SPY for six months. It was an awesome volume of data. I compiled them on EXCEL, and made the Diffusion Indices for six months in 2023.

I have to use the EXCEL Logic Formula to fill "P" and "m" which are well-known symbols of the PPO. We can type the symbols for a couple of months' data, but we can't do it manually for a jumbo data (11x0.5 year).

I want to introduce "The Sector Diffusion Index of SPY (the S&P 500 Index [SDI] now). The Jun Table is used to explain what the DI is and How to Interpret the Table, etc. [All Six Tables [66, 11, 22, 33, 44, and 55] are placed in the "TABLES" section after the main text.]

The origin of the "Paper-And-Pencil-Only (PPO)" is the founders of the National Bureau of Economic Research " [NBER], Arthur F. Burns and Wesley C. Mitchell eight decades ago.

Although We are in quite different era compared to the Michell-Burns Time, still the PPO Approach has shined in the macroeconomic research such as the monetary policy, business Cycles, Market cycles, Inflation, Labor Market, and so forth.

The PPO Approach recently has contributed on 1) the Momentum/Trend Analysis, 2) The Trifecta Distribution Front in particular. As the third contribution, the PPO Approach to monitor the Stock-Market Breath and Turning Direction.

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Diffusion Index

Uptrend, Trifecta Front, and Diffusion Index have a common thread of the PPO Approach which distinguishes any movement with a plus (“P”) and a minus (“m”) without considering the size differences.

In any special situations with any external shock such as oil embargo or pandemic Covid-19 or internal impacts of over-tightened monetary policy and undue fiscal expansion, the PPO Approach has worked to fill the vacuum of traditional fundamental or technical approaches.

Every day 11 SPY Sectors together make a Diffusion Index which oscillates between 0% to 100%. if all 11 sectors rose, the DI is 100%, and if all fell, DI is 0%. We have 11 sectors so we don't have an exact 50%. SPY had 12 sectors before. Making 11 sectors is better for DI analysis in a sense.

Jun30 in Table [66] (in TABLES), DI was 100% meaning that 11 out of 11 ascended. It’s very strong move. We can buy because the following day of one good session would repeat over 50% chance. What about a surge two days in a row, well you would make your decision, and so on. The nice thing about DI is it can be used as a market indicator at the day one.

The DI also indicates market breath which mean how tightly the components stick together. As DI goes further more sessions, more weeks, more months, the breath more accurately reveal.

The Trifecta Distribution Index [TDI] was published Jul 8, 2023. The "SDI" is introduced. I will calculate 1) Daily, Weekly, (with Jun and Jul data so far), Monthly (after getting 1H Data), Quarterly (1Q, 2Q so far), Half-Yearly (1H), and Annually (from 2024).”

( From “The Paper-And-Pencil-Only (PPO) 123“, Jul 15, 2023)

The Trend of The 2023 SDI

Table 1 is the Jul 2023 SDI, reporting 60%. The trend of 2023 is Jan 61% (Table 11), Feb 46 (Table 22), Mar 56% (Table 33), Apr 52% (Table 44), May 42% (Table 55), and Jun 59% (Table 66).

The Seven-months SDI is a final product, summarizing an extensive analysis with an awesome amount of data points. roughly 1.6 thousand (=11 sectors x 7 months x 20+ average monthly sessions).

The monthly SDI well reflected the market and the economy: 1) In July the SDI ascent to 60% to be very close to the top in Jan as 61%, 2) the most unstable month, May had the lowest point at 42%, 3) the most bearish market month, Feb also in a negative column at 46%.

I don't care much about the weekly trend. The first week and the last week quit often have some interesting features. If you are interested in, the PPO Approach does it. All you have to do is count the number of "P" each week, and pay no attention to percentages. You know you have a bullish week if the figures are greater than 5.

One of the nice things is every day we have a market signal from the SDI from the first day it is established. If you pick 11 closing prices on Aug 1 online, and write them on the next line of Jul 31 in Table1. You see only 2 "P" with XLK (Technology) and XLI (Industrial). the market was very bearish. The market was mixed: The DJIA rose but the S&P 500 and Nasdaq fell.

The first month in a year or the first week in a month, or the first day in a month are relatively important because investors are inclined to believe that the first records would repeat.in the last records.

The first five days in May were the very rare case where, starting 0% on May 1, 9% on May 2, 100% on May 3, 36% on May 4, and 18% on May 5, as shown in Table 55. in the TABLES section. The Jun SDI settled acceptably, compared to the May one because of the bullish signal.

The Investment Portfolios of The Second Batch of The DOW 30 Stocks

The Special Note: Three References, R1, R2, and R3, are put in the “REFERENCE” section after the main text to help readers:

R1: The PPO Approach, R2: Portfolios vs. Individual Stock, and R3: CORREL, The Description of the DJIA, four Batches of the DJIA, and the CORRELs among all 7 components of Part 1.

This Second Part, 8 Bull Stocks, follow the same method which was applied to the first Part, 7 Bull Stocks. The latter consist of MMM, DOW, MSFT, CAT, CSCO, AAPL, VZ, the former does of United Health (UNH), Chevron (CVX), Salesforce (CRM), Johnson & Johnson (JNJ), Walgreen Boots Alliance (WBA), Home Depot (HD), Amgen (AMGN), and International Business Machines (IBM).

Each line of Table2 from UNH to IBM has the CORRELs with other 7 Stocks:

1) UNH has 3 lower CORRELs with CVX, CRM, WBA..

2) CVX has 2 lower CORRELs with CRM, UNH.

3) CRM has 4 lower CORRELs with JNJ, CVX, IBM, UNH.

4) JNJ has 1 lower CORREL with CRM.

5) WBA has 1 lower CORREL with UNH.

6) HD has no lowering or negative CORREL.

7) AMGN has no lowering or negative CORREL.

8) IBM has 1 lower CORREL with CRM.

The 6 DJIA Bull 8 Portfolio Templates

1) UNH (35%) CVX (25%) CRM (25%) WBA (15%)

2) CVX (30%) CRM (30%) UNH (40%)

3) CRM (20%) JNJ (20%) UNH (35%) IBM (25%)

4) JNJ (50%) CRM (50%)

5) WBA (30%) UNH (70%)

6) IBM (50%) CRM (50%)

The Final Concerns

Aug 1 (Tue) and Aug 2 (Wed) the market was shaken unusually. The market pulled down drastically.

Tuesday the DJIA pushed higher to avoid a negative Trifecta. Wednesday a big mark of a negative Trifecta was logged.

Although the Uptrend is not expected to be a smooth advance, in the summer season, Jul, Aug, Sep, historically, the market would be doldrums, not a trend-reversal.

It's truthfully too early to be concerned, but I'm really alerted to the market reaction.

REFERENCE

R1. The Innovative “Paper-and-Pencil-Only” (“PPO”) Approach

The “PPO” Approach with a minimum help of EXCEL demonstrated a clear track on the coming up-/down-momentum and up/downtrend which has not been detected by clever algorithms (i.e., moving average) or sophisticated graphics or charts.

The PPO distinguishes the movement SPY or other ETFs as “P” (plus) or “m” (minus), without considering the size of changes.

Currently, The PPO approach works on 1) Uptrend, starting March 31, 2023, 2) the Trifecta Distribution Index [TDI], and the Sector Diffusion Index (SDI), as described in “Trend Investing with the Paper-and-Pencil-Only [PPO]”, Jul 17, 2023.

R2. Selecting Individual Stocks vs. Portfolios

Most investors invest in any single securities (stocks or ETFs). A single security is riskier than a portfolio, which is not just a group of securities, but is a well-selected cluster, considering mainly a lower correlation among all component to achieve your investment goal.

The portfolio templates are made by my investment experience in a couple of decades, and an extensive analysis with the observed market data which is the most trustful source. You can easily adapt any template and follow my instruction.

R3. Correlation Coefficient [CORREL]

CORREL computes how tightly to move for two components, ignoring the causality between them one way or the other. The tighter, the higher percentage. When two components move in opposite direction each other, we have a negative percentage.

Negative percentages or lower percentages are carefully selected and making a Portfolio with a bunch of three or four components

The Dow Jones Industrial Average [DJIA}

The DJIA is not a market-cap weight averaged, but a price weighted index. The DJIA moves faster than the S&P 500 and the economy, so quite often leads the market and the economy upward or downward.

Since July 10, the DJIA has moved up in 11 sessions in a row until July 24.

The 3 highest price stocks were 1) UnitedHealth ( UNH) ($505.23), 2) Goldman Sachs ( GS) ($354.19), and, 3) Microsoft ( MSFT) ($350.98), while the 3 lowest price stocks were 1) Walgreens Boots Alliance ( WBA) ($30.63, 2) Verizon ( VZ) ($34.24) and 4) Intel ( INTC) ($34.55).

We have to concentrate on higher priced stocks which have a heavier influence compared to lower price stocks.

The 4 Segments of the DJIA 30 stocks

1) The Leader (Bullish) [Bull] 7 Stocks (MMM, DOW, MSFT, CAT, CSCO, AAPL, and VZ)

2) The Bull 8 Stocks (UNH, CVX, CRM, JNJ, WBA, HD, AMGN, IBM)

3) The Laggers (or Bearish) [Bear] 7 Stocks (Hon, INTC, PG, WMT, KO, V, and AXP)

4) The Bear 8 Stocks (GS, MCD, JPM, MRK, TRV, NKE, BA, and DIS)

Fifteen “Bull” Stocks (which are 7 stocks, and 8 stocks), and Fifteen “Bear” stocks (which are 7 stocks, and 8 stocks) are just a tentative division.

The “Bull’ group happened to outperform, while the “Bear” bunch somewhat underperformed recently. All 30 DJIA stocks are well-selected blue chips. Therefore, investors should not think the latter are inferior to the former.

(From “ The Economy And The S&P 500 Led By The Dow?” Jul 31, 2023) TABLES