The Market Decline Continues - StormGuard-Armor has Triggered
On June 30th, StormGuard-Armor triggered and has thus activated the integrated Bear Market Strategies associated with each Strategy. Bear Market Strategies make their selection from among a set of defensive ETFs, such as bonds, Treasuries, and gold. The defensive selections made for our four formal Indexes are detailed in Merlyn.AI's July 4th News Release. Earlier this year StormGuard-Armor triggered on January 31st for a period of nearly two months before terminating when excessive market strength was shown in the latter half of March. 

The chart (right) details the hypothetical performance of the four Merlyn.AI Indexes relative to the S&P500 (plotted in white) during the first six months of 2022:

- MAI Tactical Growth and Income Index
- MAI Bull-Rider Bear-Fighter Index
- MAI SectorSurfer Momentum Index
- MAI Best-of-Breed Core Mom. Index

A profound divergence is visible between the MAI Indexes and the S&P500 during February and March when StormGuard-Armor forced defensive fund selections.

Six-Month Index Competitive Review 
The chart (right) illustrates the six-month hypothetical performance of the MAI SectorSurfer Momentum Index (green) relative to (1) AI ETFs AIEQ, QRFT, and BUZZ, (2) technology ETFs ROBO and ARKK, and (3) the S&P500 Index (white). 

During a period when volatility has been fairly high and trend duration has been relatively short, momentum strategies have a difficult time outperforming other strategies and the market as a whole. But, StormGuard now has the Indexes well positioned for the anticipated recession.

The S&P500 achieved its all-time high on January 3rd, the first trading day of 2022. After the market's 2021 stellar return of 28.7% investors were ready to take profits off the table — but not until 2022 so capital gains taxes could be delayed another year. The market promptly declined 9.7% in the first 3+ weeks of January and then recovered 5.1% through February 1st, providing a better exit point when StormGuard triggered. From there, the market declined another 8.1% through March 8th and then posted a monster rally of 11.1% in just over two weeks. This demonstrated sufficient strength to signal that the market would more likely move upward from here than continue to decline — thus canceling StormGuard and returning to equities from defensive funds (such as bonds, Treasuries, and gold). 
 

However, in late March a few hundred positive tests for Covid-Omicron in Shanghai, China, led to a swift and punishing lockdown of this important industrial region, freezing shipping and reigniting supply chain fears. In little over a month, the market lost another 15% effectively in an echo Covid crash. The rapid decline triggered our Oversold Indicator, which generally means "it's so bad that it's good." A 7% rally ensued but was soon taken to the woodshed when the Fed raised interest rates at a higher rate than expected, casting further doubt on the value of equities.

Feeling Defensive — No Place to Hide
The Fed giveth, and the Fed taketh away. Since the Covid crisis began, the Fed increased its balance sheet by $5Trillion (to $9Trillion) principally by buying bonds to help lower long-term interest rates and spur the economy. This was on top of government stimulus spending. The Fed's $1.2T/yr purchase of bonds came to an end in March and the Fed has begun an orderly process for reversing its purchases. This policy reversal is responsible for the heavy downward pressure on Treasuries and bonds during this market decline. The Fed is, in effect, "pulling the punch bowl away,"  

The inverted yield curve (10yr - 2yr, below) is generally accepted as the most reliable indicator of a pending recession. As of July 7th, the indicator has gone negative. The vertical bars on the chart below indicate periods of recession, generally defined as two consecutive quarters of economic decline. Q1-2022 had a decline of 1.6%. It would be surprising if Q2-2022 comes in any better. If the Fed increases lending rates another 0.75% later this month, it will further invert the yield curve as short-term Treasuries more quickly respond in kind. The Fed always dreams of a "soft landing," but instead has a record of turning its fire hoses on a burning economy too late and too long, resulting in a recession each time. Given the Fed's fixation on significant additional rate increases in the face of many signs of a seriously moderating economy, it is clear nothing will be different this time, a Fed-induced recession is on the way.
 

However, one pattern that may be different this time is that in both the 2001 and 2008 crashes there was a significant bear market rally prior to its final plunge. This time it appears that multiple factors are conspiring to prevent such an optimistic rally on the way to the pending recession. They include:

When first entering a declining market, there are many special confirmation checks made by StormGuard-Armor to try to prevent inadvertent whipsaw losses that no one enjoys in hindsight. However, this bear market has proven itself to be more than a nominal correction — it is persistent: we know that serious torpedoes remain in these waters. Thus, there are now only two ways for StormGuard-Armor to be canceled: (1) at least one of the three primary indicators (market trend, institutional momentum, and value sentiment) must be positive with the other two rising, or (2) the detection of a serious capitulation v-bottom and subsequent rebound typical of a market crash.

Hopefully, bonds and Treasuries are close to completing their market repricing given the changes in the Fed's balance sheet policy and will return as profitable defensive plays as we weather the storm ahead.