Market insights and analysis

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

2nd 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

The major U.S. stock market indexes were down last week. The S&P 500 decreased by 2.88%, the Dow Jones Industrial Average lost 1.99%, the NASDAQ Composite was down 3.53%, and the Russell 2000 small-capitalization index lost 1.06%. The 10-year Treasury bond yield rose 26 basis points to 1.99%, taking Treasury bonds lower for the week. Spot gold closed the week at $1,988.46, up 0.90%.

Stocks

With continued unrest between Russia and the West, the world is now three weeks into the war in Ukraine. In addition to the geopolitical uncertainty, investors tried to assess the inflation situation, potential slowdown in consumer spending, and expectations for a more aggressive trajectory in Federal Reserve rate hikes. Headlines were also dominated by the surge in commodity prices, with reports on Monday stating that the Biden administration was considering a possible embargo of Russian crude oil. Crude oil reached a 14-year high with West Texas Intermediate (WTI) trading above $130 per barrel at one point. On Tuesday, President Biden announced that the U.S. was cutting off all imports of Russian oil and gas. European nations announced less stringent measures due to their reliance on Russian energy imports at present.

On the economic data front, most data points came within expectations, with few surprises positive or negative. The consumer price index printed in line with expectations of 0.8% in February, 7.9% over the last 12 months. This is the highest inflation we’ve experienced since January of 1982.

Unemployment claims reached 227,000, slightly worse than the expected 220,000. January’s Job Openings and Labor Turnover Survey (JOLTS) exceeded expectations, coming in at 11.26 million compared to a 10.96 million forecast. The University of Michigan’s preliminary consumer sentiment fell to a 10-year low of 59.7, below the 61.4 expected.

The S&P 500 continues to trade below its 200-day moving average and is on pace to experience a “death cross” (50-day moving average crossing below 200-day moving average) in the coming days. The S&P 500 was down around 14% off its high and still in correction territory. At its intraday low on Tuesday, the NASDAQ Composite registered a drawdown of almost 22% from its most recent peak, technically in bear market territory.

As markets of 2022 resemble little of what investors experienced since the post-COVID crash, Bespoke Investment Group put things into technical perspective for investors reporting that the NASDAQ Composite is now in a bear market and the S&P 500 is inching its way closer to exceeding the 20% threshold to be classified as a bear market.

It has only been about 50 days since the S&P 500 peaked. Based on history, markets could continue trending downward for some time. From current levels, the S&P is approximately 20% away from pre-COVID highs.

During the COVID crash, COVID was the main contributor during the short-lived bear market. Today, markets are faced with a war, inflation, and surging commodity prices, as well as a hawkish Federal Reserve. It’s clear that the landscape behind market moves is much different this time. Almost 50 days from the S&P 500’s record highs the market is down around 12%. During the COVID crash, the market saw a much deeper drawdown of over 30%, but by this point in number of days it bottomed and was on its recovery course.

Interestingly, the NASDAQ is down more now than it was at this point during the COVID crash. Bespoke used the S&P 500’s peak in both periods as the start date to illustrate this in the chart below. The NASDAQ is down over 18% while at this point during the COVID crash it was down only 11%.

With the NASDAQ hitting bear market territory last week, Bespoke studied the historical details of prior bear markets. NASDAQ bear markets from 52-week highs typically last an average of 225 calendar days. The median is 99 calendar days, and investors experience a decline of between 30% to 35%. The current bear market took 108 days to reach bear market territory (6 days longer than average) and 32 days longer than the median. In the 12 periods shown in the table, the day the 20% threshold was reached was on average 123 calendar days before the low and 40 days before the low on a median basis.

The 20% threshold was met within two weeks of the bear market low five times in history, including the 1980 bear market when the bear market ended on the day the 20% threshold was reached. On the other end, there were three periods where the bear market low didn’t occur for at least another six months. During 1973, it took just 104 days for the NASDAQ to reach bear market territory, but then 526 days before the it finally bottomed.

Forward returns, once the 20% threshold is reached, were positive on average and median basis in the periods studied. However, the consistency of positive returns was basically a coin-flip.

Three-months post threshold, the NASDAQ’s average and median performance was over 10% with positive returns two-thirds of the time. Six and 12 months after the 20% threshold, the average and median returns were above average. In the three instances where the NASDAQ was down one year later, it was down a minimum of 20% each time.

The below chart illustrates performance through those forward months. Most importantly, it highlights that forward returns were far from uniform. There were six periods where the NASDAQ was in positive territory. In the other six periods, forward returns were negative to flat.

The forward return “ride” investors experience this time is difficult to predict, especially since the numbers show a 50/50 chance. In times of uncertainty, like now, active, risk-managed strategies are critical to help manage losses and avoid deep drawdowns.

Traditional asset-class diversification continues to fail investors so far in 2022 due to the underperformance of bonds as equity markets retreat. In the current interest rate environment, 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 when market exposure is undesirable. The fund is a key defensive component in several actively managed strategies at Flexible Plan Investments.

Bonds

The yield of the 10-year Treasury ended last week near recent highs (breaking to new highs on Monday), as unpredictability from Russia, uncertainty around the Federal Reserve rate hike path, and continued inflation pressures 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). Following a retest of the level in early March, the 10-year Treasury is holding above 2.10% as of Monday afternoon. Following an easy breakout at the 2% level, technicians are seeing wide open space above now. The 3% level was last seen in late 2018.

T. Rowe Price traders reported, “Supply factors also weighed on Treasuries, including heavier corporate borrowing and possible large-scale debt issuance by the European Union for energy and defense spending. On Monday, the spread between 2- and 10-year Treasury yields reached its tightest level since March 2020, but it began to widen as the week progressed. Tight spreads are often considered an indicator—although not an infallible one—of a coming recession. Investment-grade corporate bonds traded lower amid heavy new issuance. The combination of an active primary calendar and elevated new issue concessions on some deals contributed to the weakness seen in the secondary market.”

Gold

Last week, gold rose 0.90%, accelerating its breakout strength (see the black line in the following chart) as the yellow metal reached new one-year highs. Price action is now well above the 2021 price range as geopolitical tensions and prolonged inflation fears continue to make a case for gold into 2022 and 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

The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure was 200% long to start the week, changed to 0% at Monday’s close, and changed to 80% long at Wednesday’s close. Our QFC Political Seasonality Index favored stocks throughout last week. (Our QFC Political Seasonality Index is available with all of the daily signals 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 with some going inverse, 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) the NASDAQ to start the week, changed to 60% short at Thursday’s close, and returned to 40% short at Friday’s close. The Systematic Advantage (SA) strategy is 30% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 0% exposed until Thursday’s close when it initiated a 100% short (negative) position. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic model remained out of stocks 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.

Among the Flexible Plan Market Regime Indicators, our Growth and Inflation shows that we remain 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. 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.



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