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 rose last week, rounding out October’s strong rebound from September’s sell-off. The NASDAQ Composite jumped 2.71%, the S&P 500 gained 1.33%, the Dow Jones Industrial Average was up 0.40%, and the Russell 2000 gained 0.26%. The 10-year Treasury bond yield fell 8 basis points to 1.55%, as both equities and bonds gained for the week. Spot gold closed the week at $1,783.38, down 0.52%.

Seven out of 11 sectors were up last week. Consumer Discretionary and Telecoms were the best performers, up 3.98% and 2.04%, respectively. Financials were the worst performers for the week, down 0.90%.

Stocks

In October, the market reversed September’s bearish pattern, increasing beyond the high that occurred before September’s sell-off.

In recent months, the market has faced significant supply-chain issues, labor shortages, resulting inflation, and slowing GDP growth. The circumstances leading to each are unique to the post-COVID era, which makes it more difficult for markets to accurately price. Despite this, earnings season has begun, and companies are continuing to outperform.

On the supply-chain front, a troubling trend toward just-in-time models that reduce overall inventory has started to emerge. Just-in-time models are cheaper than those that require management of inventory, but they are less robust to the changes that we’ve seen over the last couple of years.

Continuing labor shortages are also adding to supply-chain problems. However, the U.S. may start to see more people reenter the labor market as economic stimulus and unemployment benefits phase out, the cost of goods continues to increase, and individuals’ cash reserves run low.

These factors have also contributed to inflation, which has increased to relatively high sustained levels for the last few months. There is, however, some good news on the horizon. September’s personal consumer expenditures report came in relatively low month over month, suggesting some relief on the inflation front. This may give the Federal Reserve room to reduce rates or monetary support for the economy. Regardless, the Fed is expected to announce the start of bond-purchase tapering this week.

These concerns are also affecting GDP. The initial reading for the third quarter came in at 2.0% growth on an annualized basis. This is lower than expected, but revisions may still occur.

A slowing economy is not entirely unexpected, and supply-chain and labor issues may have created an “upper limit” to GDP growth, at least temporarily. With limited supply, only so much GDP growth can occur without inflation. It’s not likely that long periods of significantly high inflation will occur without the Fed stepping in to raise rates and eliminate monetary support, which would be another headwind to GDP growth. Until supply-chain issues are resolved (which some say may not be until at least midway through 2023), GDP growth will likely be suppressed.

Despite these concerns, during the Q3 earnings season, companies continue to outperform. According to FactSet, 55.8% of S&P 500 companies have reported quarterly financial results. Of those, 82% beat earnings estimates—well above the average of 62%. Earnings have also grown 39.2% overall from last year. These earnings have helped propel the equity markets to new highs.

However, for the next few months, volatility in equities and bonds should be expected as the markets continue to digest completely novel situations and potential economic scenarios.

Bonds

Treasury yields decreased, taking a break from their recent rise. The 10-year Treasury fell to 1.55%, off from its recent October high of 1.70%.

Yields are still historically low, though rising overall. Credit spreads and term yields both fell for the week. The former indicates a healthy appetite for risk in the markets, while the latter suggests lower expectations going forward. Overall, long-term Treasurys underperformed high-yield bonds, and longer-term bonds outperformed shorter-term bonds.

The yield curve shows a minor inversion from the 20-year to 30-year periods. The 20-year Treasury offering is also relatively new (the first such offering in over 30 years), having begun only last year. It has not picked up as much traction as the 30-year Treasury. As such, the inversion between this pair may not fully represent expectations on those timescales. Instead, it may represent more of a flattening of the curve overall.

Gold

Spot gold fell last week, continuing its downward trend year to date. Other safe-haven assets, such as long-term Treasurys, were up for the week as rates declined. Falling rates are often a tailwind for gold; however, the U.S. dollar was up last week, which put more downward pressure on the metal.

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 more than nine years ago to track the daily price changes in the precious metal.

The indicators

Our Political Seasonality Index began the week out of the market but entered 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.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure was negatively exposed to the market for the week. It began 0.4X short, increased to 0.9X short on Wednesday’s close, changed to 0.8X short on Thursday’s close, and remained there to begin this 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 120% exposed on Monday’s close, changed to 140% exposed on Tuesday’s close, and changed to 160% exposed on Friday’s close. The Systematic Advantage (SA) strategy began the week 90% exposed to the market last week, changed to 60% exposed on Wednesday’s close, and changed back to 90% exposed on Friday’s close. Our Classic strategy is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long for 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 Falling reading (as of 11/1/2021), which favors gold over bonds and then equities from an annualized return standpoint. The combination has occurred 13% of the time since 2000. It is a stage of high returns for all asset classes with higher-than-normal risk for both equities and gold.



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