Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

1st Quarter | 2022

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

By Jerry Wagner

The major U.S. stock market indexes were down last week. The Dow Jones Industrial Average lost 4.6%, the S&P 500 Index fell 5.7%, the NASDAQ Composite declined 7.6%, and the Russell 2000 small-capitalization index dropped 7.9%. The 10-year Treasury bond yield slipped two basis points to finish at 1.759%, sending bond prices flat to slightly higher for the week. Spot gold closed at $1,817.38, up $17.44 per ounce, or 0.96%.

Stocks

A picture is worth a thousand words. And as the previous chart shows, the upward price trend of the S&P 500 Index was broken in January, as were both its 50-day and 200-day moving average lines. The technical picture has not been this bad since 2020. All it took to make it happen was the worst week in the equity markets since March 2020.

The NASDAQ and the Russell 2000 were not spared, as they tumbled even more. The NASDAQ has now experienced the worst start to a year in its history. As of Friday (January 21), Bespoke Investment Group reports, 42% of the NASDAQ stocks had fallen 50% or more, and 70% of them had fallen over 20%.

While 55% of tech stocks have lost more than half their value, health care components of the NASDAQ have been hit even worse. More than 70% of these stocks have seen their price cut in half or worse.

As I referenced in this week’s “In My Opinion” article, there is plenty for investors to be concerned about.

The Federal Reserve is in the throes of a significant change in direction to try to stanch the economy’s open wound of rising inflation. The New York Times reported that the Biden administration was considering sending U.S. troops to oppose a possible Russian invasion in Ukraine. At the same time, national polls were telling us that the administration was hemorrhaging supporters and many commentators feared that it had, in its first year, already become a lame duck with little chance of future accomplishments.

On the economic front, reports last week on retail sales and jobless claims were terrible. Manufacturing and housing reports were mixed. Early earnings reports for the fourth quarter generally beat expectations, but investors reacted badly to even the best of them. And in the case of Netflix, a stumble in performance sent the stock down more than 20%!

Still, as of Friday, bullish sentiment among small investors (as represented by the AAII Sentiment Survey) had fallen to its lowest decile. This is usually a contrarian bullish sign. Similarly, as a clear indication of the severely oversold positioning of the equity markets, the stock indexes had fallen three standard deviations from their moving average.

In the same vein, David Kneupper’s NASDAQ Bottom Finder indicator met the first requirement for an end to the carnage, as the measure fell to below the 20% level. It now requires a move to above 35% to signal the all-clear.

At a minimum, a dead cat bounce was expected, and we certainly saw one intraday on Monday. Stocks experienced their best single-day comeback since 2008.

Still, we are in the midterm year of the four-year presidential cycle. That usually means lower performance and more volatility. As the following chart shows, the second year of the cycle differs substantially from other years. Note that the decline is usually experienced at the start of the year. We may not see relief until mid-February if we follow the usual pattern. And then there is a second decline starting in April.

Bonds

As the chart above of the 10-year Treasury bond yield suggests, interest rates have rallied. Not only have they moved above their 50-day moving average but also their last two intermediate-term market highs. As I warned last month, they may soon rise above their 50-day moving average and establish a new uptrend. This uptrend would be costly to bond investors. And it has been expensive, with long-term Treasury bonds (TLT) falling over 5%.

However, looking closely at the right end of the chart, one can see a decline. This change in direction results from the recent substantial volatility in stocks. Bonds often provide a downside hedge against stock movements as a safe-haven asset. This is occurring once again in the current equity rout.

The bond market reaction to the two-day Federal Reserve meeting ending Wednesday (January 26) will be telling. Can it send yields higher as the Fed continues its support for both an elimination of its asset purchase program (which was still buying last week at an $80 billion pace) and rate hikes (three to four are currently predicted for 2022)? Or will yields continue to trend downward because of an increase in stock market volatility—or a Fed retreat, in the face of the economic weakness displayed in reports last week, to a more dovish strategy with less emphasis on rate increases?

Meanwhile, high-yield bonds have followed the equity indexes lower. As is usually the case, because of the higher interest rates earned, their decline has been more moderate than stocks in general. Yet, the retreat did reach the level of the November retreat before reversing higher in Monday’s turnaround.

Gold

Except for a brief dip at the start of the year, gold has remained above its 50-day moving average. The last time this happened, investors were able to garner gains before the precious metal slipped back below that mark. With the terrible inflation numbers recorded this year and the advances made by most other commodities, gold’s gains are understandable.

However, as we have consistently pointed out, the yellow metal has had to face the headwinds of a strong rally in the U.S. dollar. Typically, a rallying dollar leads to declining gold prices, and the last 12 months have generally been no exception.

Gold’s current turnaround has come not during a dollar decline but rather as the dollar's ascent has simply flattened out. Unfortunately, the following chart shows the dollar itself breaking above its moving average. This may put added pressure on gold’s price, as will ascending interest rates. So far, gold’s safe-haven status in the face of substantial stock market volatility has helped overcome these bearish pressures.

Flexible Plan is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction more than nine years ago to track the daily price changes in the precious metal.

The indicators

The short-term-trend indicators for stocks that I watch have been in a bearish posture for some time. Similarly, our Political Seasonality Index has been pointing lower since January 18. It turns back bullish on January 24 before retreating again on February 2. (Our QFC Political Seasonality Index—with all of the 2022 daily signals—is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.)

Our very short-term-oriented QFC S&P Pattern Recognition strategy has moved back to a 1.6X exposure to the S&P 500 Index.

FPI’s intermediate-term tactical strategies have been mixed. The Volatility Adjusted NASDAQ (VAN) strategy has 0% exposure to the NASDAQ, while the Systematic Advantage (SA) strategy is 30% exposed to the S&P 500 and our QFC Self-adjusting Trend Following (QSTF) strategy has an exposure of 100% invested. (VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.)

Classic continues in a 100% long position.

Among the Flexible Plan Market Regime indicators, our Growth and Inflation measure shows that we are in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and positive monthly GDP reading). This stage occurs about 60% of the time and favors gold and then stocks over bonds, although gold carries a substantial risk of a downturn in this stage.

Our Volatility composite (gold, bond, and stock market) has a High and Falling reading, with gold returns historically outpacing stocks and then bonds. This stage occurs about 13% of the time. Stocks have the most downside risk, and bonds have the highest risk-adjusted returns.



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