Market insights and analysis

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

2nd Quarter | 2022

Market insights and analysis

rss

Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

Market Update 2/22/22

By Tim Hanna

Major U.S. stock market indexes were down last week. The S&P 500 decreased by 1.58%, the Dow Jones Industrial Average lost 1.90%, the NASDAQ Composite was down 1.76%, and the Russell 2000 small-capitalization index lost 1.03%. The 10-year Treasury bond yield fell 1 basis point to 1.93%, taking Treasury bonds higher for the week. Spot gold closed at $1,898.43, up 2.13%.

Stocks

Against a background of rising tensions between Russia and Ukraine, investors tried to assess the disappointing earnings of growth stocks and coming Federal Reserve policy moves. Some investors believe the current geopolitical environment could sway the Fed into being less hawkish than anticipated. According to the CME FedWatch Tool, the probability for a 50-basis-point hike in March has decreased to 21.1% from 49.2% last week.

On the economic data front, the producer price index (PPI) hit 1.0% month over month, higher than expectations of 0.5%. Retail sales saw 3.8% month over month, higher than the 2.1% forecast. Industrial production was at 1.4% month over month compared to the 0.4% forecast. The Philly Fed Manufacturing Index came in at 16.0, below expectations of 19.0. Unemployment claims reached 248,000, worse than the expected 217,000. Housing data was mixed, with housing starts rising less than forecast and building permits above expectations.

Markets have had a rough ride since the start of 2022, and last week was no exception. Negative sentiment continued, and multiple risks are now on investors’ minds. Technicians are also grappling with uncertainty as the S&P 500 trades below its 200-day moving average following a failed move higher in early February. The 200-day moving average is a commonly followed indicator by technicians, often used as a risk-on/risk-off signal.

As markets continue to trade down against a negative technical backdrop, Bespoke Investment Group studied current market internals, providing another lens through which to view the health of the market. The cumulative advance/decline (A/D) line has been moving with price during this downturn. The magnitude of the decline in the cumulative A/D line, however, has not been as steep as the price decline. In the near term, we are watching for signs of a divergence—where the cumulative A/D line makes a higher low while the S&P 500 breaks through its recent lows.

The high-yield market has been deteriorating over recent weeks. The chart below compares high-yield spreads on an inverted basis. High-yield spreads (red line) made a higher high (shown as a lower low on the inverted chart) and have moved to their widest levels in over a year.

Given the negative news recently, it’s no surprise that sentiment has deteriorated quickly. The chart below shows a composite of net bullish sentiment as measured by the weekly American Association of Individual Investors (AAII), Investors Intelligence, and National Association of Active Investment Managers (NAAIM) surveys. Interestingly, net bullish sentiment is lower than it was at the height of the COVID crash. The indicator has fallen to its lowest level since early 2016. The only other time the sentiment gauge was lower than it is now was in 2010 and during the financial crisis of 2008.

The Bespoke team also looked at forward returns in deciles for historical bullish sentiment readings, sometimes used as a contrarian indicator at extremes. When net bullish sentiment was in the bottom decile of historical readings, forward returns were better than average. Average returns over the following month and year were the strongest for this decile relative to others.

With the recent high levels of volatility and uncertainty, it is critical to incorporate active, risk-managed strategies in a portfolio. Such strategies within a portfolio give investors the ability to adapt to market changes, which may help limit losses if this turns into a full-fledged bear market. Aside from moving to a more defensive position when markets go down, some of these strategies have the ability to profit during downturns by going inverse. Most importantly, combining strategies that use different methodologies to trade similar asset classes has been shown to reduce risk compared to holding a single strategy.

In addition, traditional asset-class diversification has failed investors so far in 2022 due to the underperformance of bonds as equity markets have gone down. Active, risk-managed strategies in the fixed-income space are more important than ever. The following chart shows the year-to-date performance of the Quantified Managed Income Fund (QBDSX) compared to the iShares Core US Aggregate Bond ETF (AGG). The Quantified Managed Income Fund is an actively managed income fund that can seek various income classes as well as the safety of cash if market exposure is undesirable. The Fund is a key component in several actively managed strategies at Flexible Plan Investments, most often as a component of defensive positioning for the firm’s actively managed strategies.

Bonds

The yield of the 10-year Treasury ended last week off recent highs as unclear signals from Russia, uncertainty around Federal Reserve moves, and mixed economic reports led to fluctuations in the Treasury market. The 10-year Treasury continues to trade above its one-year-high breakout level (see the black horizontal line in the following chart). During the beginning of the week, the 10-year Treasury traded above 2.05% before pulling back to 1.93% as market volatility increased. Technicians are watching the 2% level for continued resistance, and the 1.75% support is still intact.

T. Rowe Price traders reported, “Investment-grade corporate bond spreads moved wider during the week as headlines regarding Russia/Ukraine tensions and an acceleration in U.S. producer price inflation weakened sentiment. The primary calendar was active periodically as sentiment stabilized, and the new deals were generally met with adequate demand.

“Our traders noted that the high yield market suffered from concerns about supply issues from possible sanctions against Russia or disruptions that would not only impact the energy industry but would likely have wider implications for other inputs across sectors.”

Gold

Last week, gold rose 2.13%, accelerating its breakout strength (see the black line in the following chart) as the yellow metal tries for new one-year highs. After almost a year of sideways movement, gold is attempting to form a trend to the upside. Price action is now well above recent swing highs as geopolitical tensions continue to make a case for gold into 2022. Potential weakness in the U.S. dollar, worse-than-expected inflation, and worsening geopolitical tensions between military powers could help boost the price of gold even further as uncertainty continues across asset classes.

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 was 80% long to start the week, changed to 160% long at Monday’s close, and remained there throughout the week. Our QFC Political Seasonality Index favored stocks the first two days of last week, moving to defensive positioning at Tuesday’s close. (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 have been moving into more defensive positioning, 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 was 40% short (negative) throughout last week. The Systematic Advantage (SA) strategy is 30% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 100% long throughout last week and changed to 0% exposure at Friday’s close. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic model was fully invested last week. Most of our Classic accounts follow a signal that will allow the strategy to change exposure in as little as a week. A few accounts are on platforms that are more restrictive and can take up to one month to generate a new signal.

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 High and Rising reading, which favors stocks over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2003. It is a stage of lower returns and higher volatility for all three major asset classes.



Comments are closed.