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 up strongly last week. The Dow Jones Industrial Average gained 1.7%, the S&P 500 Index rose 2.3%, the NASDAQ Composite advanced 3.2%, and the Russell 2000 small-capitalization index picked up 3.1%. The 10-year Treasury bond yield added 9.1 basis points to finish at 1.493%, sending bond prices lower for the week. Last week spot gold closed the week at $1,808.39, up $10.20 per ounce, or 0.56%.

Stocks

The S&P 500 managed yet another new market high last Thursday, and it repeated that accomplishment as the new week began. However, as the chart above displays, market breadth has not caught up with the Index. Similarly, the Dow, NASDAQ, and Russell 2000 have not reached the same historic level. I pointed to this a month ago as suggestive of weakness in the immediate future. And that proved correct.

But this time, we have a different market environment. Most of the other indexes and measures are not falling like they were four weeks ago but instead have been rising and hitting new intermediate (although not historic) new highs of their own.

There have been quite a few reports on the economy's health of late. Some have been positive, others negative, but almost all have simply met expectations.

One report that bears watching is the University of Michigan's Consumer Sentiment Index. It continues to fall. The Bespoke Investment Group pointed out that this decline and the general directional movements of the Index are inversely matched to the Misery Index created by economist Arthur Okun, a Democrat.

The Misery Index combines the unemployment rate with the inflation rate. Bespoke suggests that as that Index goes higher, consumers probably would not be as optimistic about future economic prospects as they would be if the Index were falling. And as the chart below shows, when you reverse the direction of the Misery Index so that a rise becomes a fall, it tracks the Index of Consumer Sentiment very well indeed.

So far in 2021, the Index has soared from 7.7 to 11.01. This advance takes the Index to its fourth-highest level in the post-WWII era. It trails only the double-digit results at the end of the Nixon, Ford, and Carter administrations' years in office.

Another difference between now and a month ago is market sentiment. While the ratio of bull to bear investors in the AAII Sentiment Survey was extremely optimistic four weeks ago, it is much more bearish today. As this is a contrarian indicator, it suggests future gains compared to the predicted decline a month ago.

Bonds

As the chart above of the 10-year Treasury Bond yield suggests, interest rates appear to be at an inflection point. They may soon rise above their 50-day moving average and establish a new uptrend. This uptrend would be costly to bond investors.

However, yields have swung back and forth during the last month. Given that yo-yo action, it seems just as likely that a reversal could be coming. Investors do not generally expect this, but a short-term swing lower in yields seems quite possible given the market technicals. However, while I consider this scenario slightly more likely in the short term, it also appears that such a move could be short-lived as we are very close to the market lows established, first at the beginning of the month, and then again at the midmonth mark.

Meanwhile, high-yield bonds have shot steadily higher, mirroring the equity indexes. Like the S&P 500 Index, they have moved to a new high. They point still higher for the rest of the year.

Gold

Gold has broken out above its 50-day moving average and seems poised for a short-term rally. With the terrible inflation numbers recorded this year and the advances made by most other commodities, it seems about time.

However, as we have consistently pointed out this year, 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 this year is no exception.

It is somewhat remarkable that gold's current turnaround has come not during a dollar decline but rather as the dollar's ascent has simply flattened out. One must wonder what is in store for the precious metal should the dollar begin to fall precipitously.

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 switching from a bearish posture to a bullish one. All are improving as they join our Political Seasonality Index, which has been in the market since December 13. The Index continues fully invested through the end of the year. (Our QFC Political Seasonality Index—with all of the 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 maintained its 2X exposure to the S&P 500 Index throughout the current rally.

FPI’s intermediate-term tactical strategies have remained uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy has only a 40% exposure to the NASDAQ, while the Systematic Advantage (SA) strategy is 90% exposed to the S&P 500 and our QFC Self-adjusting Trend Following (QSTF) strategy has an exposure of 160% 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. Like Classic two weeks ago, Market Leaders switched back into a bullish posture this week after just one week in a defensive mode.

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 Rising reading, with stock returns historically outpacing gold and then bonds. This stage occurs about 23% of the time and is the most volatile regime for all three asset classes.



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