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 Jason Teed

The major U.S. stock market indexes fell significantly last week. The NASDAQ Composite tumbled 3.20%, the S&P 500 fell 2.21%, the Dow Jones Industrial Average was down 1.36%, and the Russell 2000 lost 0.29%. The 10-year Treasury bond yield rose 1 basis point to 1.46%, though bonds were largely down for the week. Spot gold closed the week at $1,760.98, up 0.60%.

Ten out of 11 sectors were down last week. Energy was the only sector that gained, rising 5.79%. Health Care and Technology were the worst performers last week, down 3.54% and 3.34%, respectively.

Stocks

September lived up to its reputation for being a bad month for the market. The S&P fell 4.76% for the month. Concerns about COVID, inflation, and China’s energy crisis all contributed to the poor market performance.

COVID continues to be an ever-present—though waning—source of uncertainty in the market. The delta wave appears to be receding, despite the beginning of the school year.

It also appears that the vast majority of Americans now possess COVID antibodies. Whether by natural infection or vaccination, about 83% of Americans have some level of protection. Given those numbers, it seems unlikely that we’ll see the COVID numbers that we saw last winter.

Additionally, several drugmakers are working on COVID-specific treatments, further reducing the concerns that lockdowns would be necessary to flatten the curve for hospitals. Ultimately, it seems more likely that we’re approaching a place where learning to live with COVID will be the new normal.

Inflation also continues to be a concern. The inflation the Federal Reserve labeled “transitory” is seeming less so now that it’s projected to continue for many months.

Currently, it’s expected that the supply-chain issues that have caused much of this inflation may take one to two years to subside. For example, supply-chain issues have significantly increased the cost to ship goods. Those additional costs will ultimately trickle down to consumers. Since January 2020, the Harpex container shipping cost index has risen over 400% percent.

Additionally, shippers are having trouble unloading their cargo due to labor shortages, leading to backed-up anchorages full of products sitting in limbo.

Ultimately, the market will have to decide how long these price increases can remain before being considered less “transitory” and more permanent. Only time will tell whether the damage done by the pandemic can be quickly reversed or if inflation will slow only after a long period of high prices.

Higher, sustained inflation may lead the Fed to a more aggressive stance regarding interest rates. Ultimately, a more hawkish Fed would decrease the value of bonds and put the brakes on the economy as a whole, leading to a decrease in earnings and therefore stock prices.

It is a difficult situation to navigate. Inflation is not simply the result of out-of-control economic growth in this instance (which would suggest an increase in interest rates is appropriate), as the equity markets may remain somewhat unstable while the Fed attempts to find a path forward.

Taking the path of higher rates more quickly can quash inflation concerns, but it may also rattle markets as the world continues to deal with COVID. Leaving interest rates lower for longer, however, risks exacerbating inflation concerns, which could cause economic issues down the road.

China is experiencing an energy crisis as a consequence of its internal energy policies and the continued effects of the COVID pandemic. China has a primarily coal-generated electrical grid. Following the COVID reopening, the use of coal stores increased as part of stimulus measures that were passed.

However, this increased use (among other trends) has led to a decrease in the supply of coal domestically, raising its price. Chinese utilities are barred from raising rates. To prevent operating at a loss, many are simply shutting down power plants. The result is electricity rationing, which is hitting various manufacturing sectors.

This will introduce further supply-chain issues to an already strained global economy and potentially lead to further inflation worldwide. These effects will be temporary, but their magnitude is currently unknown.

Bonds

Treasury yields increased, continuing their slow rise. The 10-year Treasury climbed to 1.46%, up from the low of 1.17% in August.

Yields are still historically low. Credit spreads rose for the week, and term spreads increased slightly. The former indicates hesitancy in the markets, while the latter suggests stable conditions. Overall, long-term Treasurys underperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

The yield curve shows a minor inversion after the 1-month period, suggesting the market may be pricing in a slight economic decline soon, though long-term projections appear healthy.

Gold

Spot gold rose last week, rebounding somewhat from its longer-term decline from the 2020 peak. The metal is still down year to date. Other safe-haven assets, such as long-term Treasurys were down for the week, which makes gold’s gain all the more impressive. The U.S. dollar was up last week, which highlights the high demand for the metal, as there is typically an inverse relationship between gold and the dollar.

Flexible Plan Investments (FPI) is the subadvisor 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 Political Seasonality Index began the week fully exposed to the market, exited on Tuesday’s close, and entered the market again on Thursday’s close. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure began the week 0.5X long, changed to 0.8X long on Tuesday’s close, and remained there for the rest of the week.

Our intermediate-term tactical strategies are uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy began the week 140% exposed, changed to 100% exposed on Wednesday’s close, and remained there for the week. The Systematic Advantage (SA) strategy began the week 120% exposed to the market last week. It changed exposure each day, alternating between 60% and 90% exposure. Our Classic strategy is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long to start the week. It changed to 80% long on Tuesday’s close, changed to 100% on Wednesday’s close, and remained there to begin the 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, one of our Market Regime Indicators, 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 also 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 equities over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2000. It is a stage of low returns for all asset classes.



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