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 Flexible Plan Investments

The major U.S. stock market indexes were mostly up last week. The Russell 2000 gained 1.57%, the S&P 500 rose 0.82%, the NASDAQ Composite climbed 1.08%, and the Dow Jones Industrial Average lost 0.06%. The 10-year Treasury bond yield rose 3 basis points to 1.96%. It continued an upward trend that began in mid-December, though it fell sharply coming into this week. Spot gold closed at $1,889.34, down 0.48% for the week.

Eight out of 11 sectors were up last week. Health Care and Real Estate were the best performers, rising 2.71% and 2.69%, respectively. The Consumer Discretionary sector was the worst performer for the week, down 2.16%.

Russian-Ukraine conflict and financial impact

Tensions in Eastern Europe escalated early last week as Russia recognized the independence of two breakaway pro-Russian regions in Ukraine. The U.S. responded by putting sanctions on the two regions. Russia escalated the situation by sending troops into Ukraine. Over the weekend, Russia put its nuclear forces on “high alert,” and other global powers placed economic sanctions on Russia and offered monetary and armament support to Ukraine. Effects on the market will be varied and unpredictable.

Oil

One consequence of Russia’s invasion of Ukraine is the rise in the price of oil, which had already been steadily increasing due to concerns about inflation. The commodity spiked before returning to levels consistent with the recent trend after market participants digested the news. It’s likely the conflict will put further upward pressure on the resource as Russia contributes about 10% of the global supply of crude oil. The removal of several key Russian banks from the SWIFT system makes it more difficult to transact with Russian oil producers. Reuters reports that Goldman Sachs “raised its one-month Brent price forecast to $115 a barrel from $95 previously.”

One approach that would allow for greater leverage over the Russians in situations like this while lowering oil prices and inflation here and globally, according to Flexible Plan Investments’ president Jerry Wagner, would be to take measures to pressure U.S. oil and natural gas companies to increase production. At the same time, the U.S. could loosen up previously imposed restrictions on oil and natural gas production and transport in the United States. The U.S. remains the number one oil producer in the world, yet it is currently purchasing increasing amounts of relatively “dirty” Russian oil, (averaging 20 million barrels a month, up 30% in 2021 over 2020) and has put itself in a corner of not being able to increase assistance to Europe to reduce their dependence on Russian energy. Unfortunately, the political situation in the U.S. makes this option unlikely to be implemented.

Domestic equity markets

Equity markets may offer a less bleak picture than oil. The U.S. stock market had been trending downward since the beginning of the year due to a combination of expected increased interest rates and labor shortages. Once news of tensions in Eastern Europe began, the market responded by selling off through Thursday’s open. The market swiftly rebounded from that point. At present, it is up more than before the February crisis began.

There are a couple of likely reasons for this: 1. It’s expected that the Federal Reserve may try to offset recessionary pressures from the conflict by being less aggressive in raising interest rates. 2. Before Russia sent troops into Ukraine, how the crisis would play out caused a lot of uncertainty. Once Russia invaded, that uncertainty vanished. The market, which favors certainty, climbed. Such occurrences are common in the market.

Traditionally, these types of events have minimal impact on markets in the long term. (In fact, there is an old stock market axiom: “Buy when the bullets begin to fly.”) However, in some instances, these types of events have exacerbated losses.

The conflict may also add to economic pressures that already exist, including inflation caused by supply issues, which tend to cause stagflation. And more supply shocks are possible, which could result in additional headwinds for the U.S. economy and lower expected growth.

International equity markets

Sanctions have had a major economic impact on Russia. Russian markets remained closed Monday (February 28), and the ETF that tracks Russian companies (RSX) is down 49% since last Tuesday—and down about 20% Monday alone.

Markets abroad have been responding to events with greater volatility than in the U.S. While the S&P is nearly unchanged from February 18, the EAFE Index is down about 3%, and emerging markets and China are down about 5% each.

Both Europe and China are more closely tied economically to Russia than the U.S., and it makes sense that both would bear the brunt of these sanctions as well. At least until the end of the current conflict, those markets are likely to experience greater volatility than domestic markets.

Currencies

The U.S. dollar has increased in value since the invasion of Ukraine began. It is often used as a safe-haven asset, and the U.S. dollar is more isolated than other major currencies.

Since February 18, the euro has fallen about 1%, the British pound has fallen about 1.3%, and the Russian ruble has fallen about 25%. This highlights the effectiveness of recent sanctions, which some feared would be hampered by the advent of cryptocurrencies and efforts by Russia and China to remove the U.S. dollar from transactions between their countries.

However, sanctions appear to be strongly affecting the ruble, resulting in a run on Russian banks as citizens fear lost access to their funds. In response to sanctions, the Russian central bank increased its rate from 9.5% to 20%, though this has not stopped the currency from falling relative to the U.S. dollar.

The ruble will continue to experience pressure, but the U.S. dollar will likely enjoy the benefit of remaining a world reserve currency. As European countries will be more significantly impacted by current events, the U.S. dollar is likely to continue appreciating against the euro and British pound.

Bonds

Treasury yields were unaffected by the invasion of Ukraine, remaining elevated in a run-up from mid-December. The 10-year Treasury rose to 1.96%.

Yields throughout the curve rose last week, though the term yield did shrink by 6.7 basis points. Credit spreads rose by nearly 8 basis points. Both of those movements indicate a reduction in risk appetite in the market. Overall, long-term Treasurys underperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

The yield curve seems healthy, with rates increasing from short to long maturities. The market expects that rates will continue to rise as the Federal Reserve begins to combat recent inflation. Overall, the yield curve continues to suggest a rising rate environment, particularly in the next couple of years.

Gold

Spot gold was down last week, though it has risen significantly overall in the first half of February. Other safe-haven assets, such as long-term Treasurys, were also down for the week as rates increased. Increasing rates are often a headwind for gold.

Gold is typically a safe-haven asset in times of crisis, but market response to the Russia-Ukraine conflict has been muted so far—and may remain so unless the conflict escalates significantly.

Flexible Plan Investments 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. It entered on Wednesday’s close and remained there to begin this week. (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 began the week 1.6X long. It changed to 2X long on Tuesday, sold off on Wednesday, and remained there for the rest of the week.

Our intermediate-term tactical strategies have mixed exposure. The Volatility Adjusted NASDAQ (VAN) was 40% inverse the NASDAQ 100 for the week. The Systematic Advantage (SA) strategy began last week 30% exposed to the market. It changed to 60% exposed to begin this week. Our QFC Self-adjusting Trend Following (QSTF) strategy was completely unexposed to the markets for the week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic strategy remained in the market last week. It sold out of its position on Tuesday’s close this week. The strategy can trade as frequently as weekly.

Except for the Market Leaders strategies, all of our top strategies significantly pulled back equity exposure. On the aggressive end, our turnkey strategies were only 25%–30% exposed to the markets as of the end of last week. Conservative strategies were even less exposed.

Our individual strategies have responded to market movements in different ways, depending on their rule sets and goals. Both QFC Market Leaders and QFC Evolution Plus had very little exposure to equities.

Exposure varied among our QFC All-Terrain strategies, each of which is powered by different mechanisms. The more conservative QFC All-Terrain strategies, which don’t employ leverage, remained in the markets longer than the aggressive strategies, which do employ leverage.

This highlights the ability of our turnkey strategies to navigate the different strategies we offer to create a composite strategy that can take advantage of a plethora of trading methodologies.

The response of our subadvised family of Quantified Funds also differed. Our most aggressive funds, which can invest in equity, reduced exposure the most. Our two unleveraged offerings, the Quantified Common Ground Fund and the Quantified Rising Dividend Tactical Fund, remained mostly invested in the markets as they are designed to do. Both are outperforming the S&P year to date, with the Quantified Common Ground Fund outperforming by about 3% for the year through Friday (February 25).

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 Rising reading, which favors equity over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2000. It is a stage of lower returns and higher volatility for all three major asset classes.



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