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 Tim Hanna

Major U.S. stock market indexes were down last week. The S&P 500 decreased by 2.20%, the Dow Jones Industrial Average was down 1.97%, the NASDAQ Composite fell 3.52%, and the Russell 2000 small-capitalization index lost 4.15%. The 10-year Treasury bond yield fell 7 basis points to 1.47%, taking Treasury bonds higher for the week. Spot gold closed at $1,802.59, down 2.34%.

Stocks

Before the omicron variant rattled markets on Friday (November 26), the S&P 500 had set an all-time high and economic data was quite upbeat. During the holiday-shortened week, President Joe Biden announced his intent to nominate Jerome Powell for a second term as Federal Reserve chair and Lael Brainard for vice chair of the Board of Governors.

The Russell 2000 small-capitalization index, the hardest-hit major index last week, filled its breakout gap and is testing the 200-day moving average following last week’s move.

On the economic data front, unemployment claims came in at 199,000, lower than the anticipated 259,000. Last week’s reading was the lowest since November 15, 1969. Existing homes sales were at 6.34M versus the expected 6.20M, while new home sales came in at 745,000, lower than the expected 801,000. The revised University of Michigan Consumer Sentiment number was slightly higher than the anticipated 66.8, coming in at 67.4 on Wednesday. Flash Manufacturing PMI was 59.1 versus expectations of 59.3, and Flash Services PMI registered 57 compared to the expected 59.1. Core PCE Price Index (month over month) was in line with expectations of 0.4%.

Markets moved higher most of the week on President Biden’s announcements, healthy economic data, and general momentum within the current market environment. But markets were rattled hard by Friday’s news about the omicron variant, a new COVID variant of concern, that emerged in South Africa. Investors’ fear of global spread and renewed lockdowns and economic downturns were reflected in Friday’s price action.

With the omicron variant consuming financial new headlines at the end of last week, Bespoke Investment Group released research focused on S&P 500 downside gaps related to COVID-19. The S&P 500 experienced its worst opening gap in over a year following the news about the new variant. Bespoke found that since the low on March 23, 2020, large gaps down for the market—whether due to news related or unrelated to COVID—have not resulted in longer-term downtrends.

The S&P 500 (SPY) gapped down 1.49% at the open on Friday. This was the worst opening since October 28, 2020, when the S&P 500 gapped down 1.81%. The last time the market opened down more than 1% was in July 2021, as the delta variant began to rise and investors raised concerns about global growth. Before that, the initial emergence of the delta variant in the United Kingdom at the end of 2020 was the last time that SPY opened down more than 1% on COVID news. The following chart shows all downside gaps of more than 1% since the COVID-crash low on March 23, 2020. Gaps down on COVID-related headlines are highlighted in red with numbers corresponding to the specific headlines in the table.

Focusing on the gaps down due to COVID news, performance from open to close has been mixed, with gains occurring about 50% of the time. Interestingly, performance has leaned positive more recently versus earlier in the pandemic, possibly due to greater uncertainty surrounding the virus earlier on. Over the week following a 1%-plus gap down, overall performance has consistently been positive. Gains occurred every time except during March of last year, which was shortly after the bear market ended. On average, from that lower open to the close one week following, SPY has gained 2.79%.

As we experienced last week, shocks give little warning and come in different degrees, speeds, and intensities. The effect could be a prolonged bear market or a quick recovery. Incorporating active, risk-managed strategies can help manage downside risk in periods when market volatility is prolonged, with certain strategies being able to profit in markets that are in an established downtrend.

Bonds

The yield on the 10-year Treasury fell 7 basis points to 1.47%, ending the week right at the support line of the uptrend that started in August. Positive economic data and more certainty regarding the future Federal Reserve chair helped move yields up earlier in the week.

Inflation and rate-hike expectations were tempered last week. According to the CME FedWatch Tool, the probability for a rate hike in May 2022 decreased to 36.4% from 55.3%, and the probability for a June 2022 hike dropped from 82.1% to 61.8% on Wednesday. Friday’s COVID news led investors to flee to lower-risk assets, causing the 10-year yield to fall to its lowest level in over two weeks.

T. Rowe Price traders reported “positive flows into municipal bond portfolios industrywide and very light deal activity during the holiday-shortened trading week. The firm’s high yield corporate bond traders noted that the market was weak amid lighter-than-average trading volumes.”

Gold

Last week, gold fell 2.34%, once again trading at its 50-day and 200-day moving averages. Following a breakout in early November, price is back to levels where the breakout started. The yellow metal has struggled to form a sustained trend most of 2021, currently trading in the middle of its yearly high and low that were both set in the first quarter. At present, a move higher could trigger a golden cross (when the 50-day average crosses above the 200-day average), a signal that is extensively followed by market technicians. The pullback last week is testing support at the recent swing-low trend line in black on the following chart. Consistent higher swing-lows could be the start of an intermediate-term bull price channel. If support holds, the sustained price action above the 50-day and 200-day moving averages, as well as a confirmed golden cross, are indicators of interest in the near term.

Flexible Plan Investments is the subadviser 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 very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure started last week 160% long. It changed to 200% long on Tuesday’s close and to 160% long on Wednesday’s close, where it remained to start this week. Our QFC Political Seasonality Index favored stocks last week. (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 120% long to the NASDAQ. It changed to 140% long on Wednesday’s close and to 100% long on Friday’s close. The Systematic Advantage (SA) strategy is 120% 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 200% 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 Low and Falling reading, which favors stocks over gold and then bonds from an annualized return standpoint. Historically, stocks have experienced the lowest maximum drawdown while in this regime relative to the other volatility regimes. The combination has occurred 37% of the time since 2003.



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