This Beats the S&P 500 and Gives You an Automatic Exit Strategy for Bear Markets

By TradeSmith Editorial Staff

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After making new all-time highs on the second trading day of January, the stock market has gone mostly downhill since.

Inflation has been spiking higher for months now, and the Federal Reserve is talking tough about raising interest rates to help put a lid on rising prices. Along with high valuations for many stocks, the Fed and inflation have conspired to create this downtrend.

And it’s difficult to know for sure if we are near the end of the downtrend or if it’s just getting started.

As individual investors, we may not know where the market is headed next, but we should all have an investment game plan in place no matter which way the market moves.

On that note, plenty of investors lately have been asking us: “Should I get out now, or buy the dip?” And TradeSmith has an answer.

It’s a simple, all-weather investment strategy capable of outperforming the market when stocks are heading higher, and more importantly, giving you an easy exit strategy when stocks move lower.

The TradeSmith Sector SPDR ETF Strategy

This simple strategy (which we introduced in August 2016) beats the S&P at its own game. It has outperformed the S&P 500 Index since 2000, producing a total return of 332.1% compared to the S&P 500 gain of 223.4%.

It is based on the 11 individual exchange traded funds (ETFs) that track each sector of the S&P 500. Below is the full list from our Market Outlook page, which gives you an unbiased, comprehensive look at the health distribution of each sector.

As you can see, despite the downtrend so far this year, the majority of S&P sectors remain in the Green Zone and in a healthy state.

Only the Communication Services (XLC) and Consumer Discretionary (XLY) sectors are in the Red Zone. That signals an unhealthy state and that these sectors have stopped out according to our trusty TradeStops system.

This means that if you own any stocks in these two sectors, you should consider cashing out. Or at the very least, pay close attention to the individual stops on your stocks.

One sector, Real Estate (XLRE), is in the Yellow Zone, which is not unhealthy, but a neutral reading. The Yellow Zone, like a flashing yellow traffic light, tells you to proceed with caution. The real estate sector has pulled back more than halfway to its Health Indicator Trailing Stop level.

Our Sector SPDR ETF strategy uses these valuable TradeSmith tools to invest in all 11 of the S&P 500 sector ETFs as long as they are in a healthy state.

Plus, it gives you a valuable, easy-to-follow exit strategy to get out of harm’s way if any of the 11 sector ETFs fall into the Red Zone.

Here’s how this simple, seven-step strategy works:

  1. Anytime eight or more ETFs are in a healthy state (in the Green or Yellow zones) you invest in each of the healthy sector ETFs using our Risk Rebalancer for your allocation.
  2. If any of the ETFs stop out (fall into the Red Zone), sell them immediately and keep that money in cash.
  3. At the start of each month, determine if there are still eight or more ETFs in a healthy state.
  4. If that’s true, then check for any new buy signals in ETFs that may have been stopped out previously.
  5. If there are fresh buy signals, purchase those ETFs, and rebalance your portfolio.
  6. If fewer than eight ETFs are healthy, continue to hold your healthy ETFs and keep the rest of your money in cash.
  7. Always rebalance at the end of the year if there are no monthly changes to your portfolio.

Below you can see the powerful results of the TradeSmith Sector SPDR ETF strategy for yourself.

As you can see, this strategy easily beat the S&P 500 Index with a 332.1% total return since 2000.

That’s 1.5 times the index return of just 223.4% over the same period.

Even better, our strategy had less risk and smaller average drawdowns, even in volatile markets like the one we’re experiencing right now.

The beauty of this system is that it’s easy to follow. It takes only a few minutes of your time each week to monitor. And usually there are very few trades you need to make to aim for these market-beating results.

You simply keep your money working in the healthiest sector ETFs. And if one or more falls into the Red Zone, you sell it and raise cash. That way, if the market falls into a steeper downtrend, you have an automatic exit strategy.

Also, the Sector SPDR ETF strategy tells us a lot about the health of the stock market overall. Is the market healthy, with most sectors in the Green Zone? Or is the market’s health deteriorating, with more Yellow- and Red-Zone sectors?

This information alone gives you a valuable edge in the stock market.

Despite the recent market volatility, eight out of 11 ETFs are still healthy. Because only two of the sector ETFs now have a sell signal, our system still sees the possibility for more upside ahead.

This reflects the best way to think about stocks right now. The volatility is a caution sign, telling us to be extra attentive. But it isn’t time to run for the exits just yet.