Market insights and analysis

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

3rd Quarter | 2021

Market insights and analysis

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

By Tim Hanna

Major U.S. stock market indexes were mostly up last week. The S&P 500 increased by 0.79%, the Dow Jones Industrial Average was up 1.22%, the NASDAQ Composite gained 0.09%, and the Russell 2000 small-capitalization index was down 0.38%. The 10-year Treasury bond yield rose 15 basis points to 1.61%, taking Treasury bonds lower for the week. Spot gold closed at $1,757.13, down 0.22%.

Stocks

The debt ceiling, inflation, infrastructure, shortages of raw material, and disruptions to supply chains continued to influence trading at the beginning of last week. However, markets popped on Thursday (October 7) after the Senate passed a bill to extend the debt ceiling by $480 billion until December 3. However, the S&P 500’s move up was greeted with resistance at the 50-day moving average.

Markets continue to focus on economic data, specifically related to jobs and employment. The Federal Reserve has said repeatedly that data will drive its decision on when to taper.

On the economic data front, unemployment claims were at 326,000, compared to the 350,000 that were expected. The unemployment rate came in at 4.8% versus expectations of 5.1%. Average hourly earnings (month over month) were 0.6%, higher than the expected 0.4%. The biggest miss relative to forecasts was in nonfarm employment change, which came in at 194,000 compared to the expected 490,000.

With such volatility in the jobs data over the months, some investors believe the Federal Reserve could delay its taper announcement beyond November. Also, higher hourly earnings reflect inflation pressure from supply constraints.

September brought a considerable rise in volatility relative to what investors experienced during the summer months. When studying market history, much of this volatility can be attributed to seasonality. Since 1952, October has experienced the highest frequency of moves of more than 1%, at 25%. In these terms, October and November are the two highest volatility months and December is the lowest with a frequency of 17.6%. The average frequency across all months is 20.5%.

Bespoke Investment Group also looked at the rise in volatility another way. They studied the rolling one-month average absolute daily change for the S&P 500 throughout the calendar year. The orange line in the following graph shows the rolling one-month average absolute daily change for all years, and the blue line shows the rolling one-month change so far in 2021.

The orange line highlights the steady increase in daily volatility that the S&P 500 experiences historically at this time of year. This year (blue line) the rise in volatility since the start of September is in-line with the historical norm.

With some room to go before volatility historically begins to decline into the holiday season, we’re seeing low readings in net bullish sentiment. Bespoke created a composite sentiment index combining the sentiment surveys from the National Association of Active Investment Managers, the American Association of Individual Investors, and Investors Intelligence Advisors. The composite index has dropped to its lowest level since April 2020 when the U.S. was in the middle of national lockdowns.

From a practitioner’s perspective, sentiment surveys tend to be contrarian in nature. Considering where we are seasonally, and with new lows in net bullish sentiment, markets could be lining up for a retracement to higher levels.

Bespoke studied the median performance of the S&P 500 by decile following various sentiment readings. Currently, between the 10th and 20th decile, the S&P 500’s median performance over the following one, three, six, and 12 months has been better than average, ranking at least in the top four in terms of performance across each of the time frames. The median three-month return of 5.58% ranks highest of any decile for the time frame.

Only time will tell whether markets do experience more volatility in the near term before moving higher during the holiday season. Incorporating active, risk-managed strategies that take advantage of historical seasonality in markets can generate alpha within an investor’s portfolio. More importantly, they can help manage downside risk in periods when market volatility is prolonged, with certain strategies being able to profit as markets are in an established downtrend.

Bonds

The continued expectations of tapering and future interest rate increases helped push the yield on the 10-year Treasury up by 15 basis points to 1.61%. The 10-year Treasury is clearly out of the bear price channel that started forming in May 2021 and now looks to be on its way back to highs set earlier this year.

As we have pointed out before, 1.55% was the level to watch for resistance, which was easily broken. The next area of resistance to watch for is the 1.75% range, the highs that were set in the first quarter. A breakout from the highs could be met with momentum that may push the 10-year Treasury to 2.00%, a level that hasn’t been seen since 2019.

T. Rowe Price traders reported, “The high yield corporate bond market was weaker as growth and inflation concerns weighed on the performance of risk assets. D.C. gridlock also seemed to be a primary concern for investors amid continued uncertainty around the Biden administration’s spending agenda. Our traders noted that sellers remained active in the high yield space despite the temporary bipartisan resolution to the debt ceiling issue, which led to improvement in broader markets.”

Gold

Last week, gold closed down by 0.22%, once again experiencing resistance at the 50-day moving average. The yellow metal continues to trade in the lower half of its 2021 price range, drifting closer to yearly lows as the months go by. For most of the year, price has traded below its 50-day and 200-day moving averages. At the moment, both are downward sloping, and upward moves in price have been met with resistance at moving averages and swing highs.

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

The indicators

Our very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure was 80% long throughout last week. Our QFC Political Seasonality Index favored stocks last week and traded into a defensive position on Friday’s close. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.)

Our intermediate-term tactical strategies are positive, although to varying degrees. The key advantages these strategies offer to investors is their ability to adapt to changing market environments, participate during uptrends, and adjust exposure to more defensive posturing during downtrends.

The Volatility Adjusted NASDAQ (VAN) strategy started last week 100% long to the NASDAQ, changed to 80% on Monday’s close, and remained there to end the week. The Systematic Advantage (SA) strategy is 60% exposed to the S&P 500, and our Classic model is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy was 100% long throughout last week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Flexible Plan’s Growth and Inflation measure is one of our Market Regime Indicators. It shows that we remain in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and positive monthly GDP reading). Historically, a Normal environment has occurred 60% of the time since 2003 and has been a positive regime state for stocks, bonds, and gold. Gold tends to outpace both stocks and bonds on an annualized return basis in a Normal environment but carries a substantial risk of a downturn in this stage. From a risk-adjusted perspective, Normal is one of the best stages for stocks, with limited downside.

Our S&P volatility regime is registering a High and Rising reading, which favors stocks over gold and then bonds from an annualized return standpoint. Historically, stocks have experienced the highest maximum drawdown in this regime. The combination has occurred 23% of the time since 2003.



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