Market insights and analysis

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

4th 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 Jerry Wagner

The major U.S. stock market indexes were down last week. The Dow Jones Industrial Average lost 0.9%, the S&P 500 Index gave up 1.2%, the NASDAQ Composite sank 2.6%, and the Russell 2000 small-capitalization index fell 3.9%. The 10-year Treasury bond yield declined 12 basis points to finish at 1.34%, sending bond prices higher for the week. Spot gold closed the week at $1,768.03, down $75.78 per ounce, or 0.44%.

Stocks

As the chart above shows, there was plenty of fuel to keep the uptrend in the S&P 500 going last week. All three of these traditional indicators remained positive despite the decline in the Index in the last six trading days. Many attribute the decline (which was still less than 4% before the December 6 rally) to the omicron virus variant. Others say that it was due to Chairman Powell’s statements suggesting that Federal Reserve tapering could start months earlier than suggested just weeks before.

More on both of these later. I believe the real reason for the decline was that the broad market’s technical underpinnings of the currently severely overvalued market required that stocks pause here. As I said in the Market Update in late November, “The S&P 500 hit yet another new high last week. Unfortunately, a host of daily indicators, including the advance-decline line … did not confirm. … They may suggest that a trend change is imminent.”

While that trend change is still being resisted by the S&P 500 Index, the tech-heavy NASDAQ has decisively broken its 50-day moving average and seems headed lower to test its 200-day moving average. The same is the case for the various small-cap indexes. Even the venerable Dow Jones Industrial Average sank below the 50-day measure.

The movement has not been straight down. Throughout last week, we alternated between gains and losses of about 1%. By the end of the six-day period, the Dow had moved over 4,000 points from its gains and losses (measuring between its intraday highs and lows)—equal to more than 10% of its value.

Omicron and Powell certainly spurred on the declines. The omicron variant scared Wall Street with memories of shutdowns and lockdowns. Yet hard news was difficult to find. The variant appeared more contagious, but the few emerging reports suggested it was less lethal. Meanwhile, the virus itself seemed to be backing off from its recent surge. Death rates are down significantly, although the difference between that experienced by the vaccinated and unvaccinated remains significant.

Powell and at least one other Federal Reserve Board member suggested last week that tapering may end earlier than originally suggested. The stock market reacted badly. A wave of fear broke over the canyons of Wall Street. Someone was actually suggesting that the liquidity “punch bowl” needed to be removed to truly dam up the rising tide of inflation. When the Fed last began raising rates in 2015, the result was a double-digit decline in the S&P.

Economic reports were numerous last week. But when the ink was dry and the results announced, there were 18 positive surprises and 16 negative ones. Home sales and the strength of the services industries were great, but consumer confidence and manufacturing disappointed. The big report was employment, and it was mixed. Unemployment was down to 4.2%, but, shockingly, only 210,000 new jobs were created. And all of this economic news was not enough. This week we’ll hear more about inflation as the consumer price index is reported.

Bonds

Stocks were not the only asset classes making big news last week. Bonds soared. Rates on the 10-year Treasury bond tumbled 18% during the last six days. (Note, we are at the 200-day-moving-average support level, so this rally may be short-lived.)

Of course, some of this was due to a flight to quality from the volatility riling the stock market. But fear in the bond pits was also to blame. The fear was not just that the Fed was going to raise rates, providing the final death blow to a more than 30-year-old bond-market rally. The concern was that it was going to overdo it and send the nation into a recession.

In response, the yield curve flattened. In other words, short-term rates went up while longer duration bond rates, such as the 10-year rate, tumbled. The ratio of the two-year rate to the 10-year rate has provided an early warning of recession in the past. However, as the following chart shows, while the ratio is moving higher, there is little to worry about so far.

High-yield bonds were able to resist the stock market losses as their bond side predominated. The decline in yields overpowered the decline in equity prices, and high-yield bonds gained ground last week.

Gold

Normally, with all of the fear in the bond and stock markets, one would expect gold to rally. While there were some positive days last week, by the week’s end, gold finished lower.

The lessening of inflation fears, given declines in oil and natural gas, undercut a principal argument for holding the yellow metal. Fueled by the Fed’s anti-inflation rhetoric, the U.S. dollar continued its rally. And a strong dollar is normally anathema to a gold rally.

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 we watch are all pointing lower. Our Political Seasonality Index has been in the market, but it signaled that investors should step aside at the close on Tuesday (December 7). After a week’s hiatus, the Index is suggesting a return to stocks on December 13. (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, after being out of stocks for days, changed course and has just moved into a 1.6X exposure to the S&P 500.

FPI’s intermediate-term tactical strategies have been uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy has only a 40% exposure to the NASDAQ, 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 200% invested. (VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.)

But at Tuesday's close, our Classic and QFC Classic strategies broke rank and moved into a 100% defensive position in gold and bonds.

Classic has been fully invested in equity investments since April 9, 2020. Previous to that trade, the signal exited stocks on March 6, 2020, until March 13, 2020, and then April 3, 2020, until April 9, 2020. Both were profitable trades. Most of our Classic accounts follow a signal that will allow us to buy back into stocks in as little as a week. A few accounts are on platforms that only allow less-frequent trading and can take up to one month to generate a new signal.

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 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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