Market insights and analysis

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

1st 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 Tim Hanna

Major U.S. indexes ended mixed last week. The S&P 500 increased by 2.71%, the Dow Jones Industrial Average was up 1.95%, the NASDAQ Composite was up 3.12%, and the Russell 2000 small-capitalization index lost 0.46%. The 10-year Treasury bond yield fell 6 basis points to 1.66%, as Treasury bonds rose for the week. Spot gold closed at $1,743.88, up 0.84%.

Stocks

Last week, the Dow Jones Industrial Average and the S&P 500 continued into record territory, while the Russell 2000 small-cap index underperformed. Robust economic data helped fuel the momentum in stocks last week. Another factor contributing to growth prospects was President Biden’s announcement of a $2.25 trillion infrastructure plan. Investors were encouraged that President Biden said that he would negotiate on the amount of corporate tax increase that would pay for the bill.

The Bureau of Labor Statistics reported that employers added 916,000 jobs in March, well above estimates of 652,000 and the most since August of last year. Non-manufacturing PMI came in well above estimates at 63.7 (58.3 was forecast). The JOLTS job openings for February hit the highest level since January 2019, 7.37 million (6.91 million was forecast).

Unemployment claims were at 744,000, surprisingly higher than the 682,000 forecast. Investors did not show much concern since the data-heavy week was filled with more upside surprises.

One area of concern on the data front last week was that the producer price index jumped to 1%, double consensus estimates of 0.5%. That brought the year-over-year increase to 4.2%, which is the largest in almost 10 years.

Bespoke Investment Group noted that last week’s rally pushed the S&P 500 to more than 2.5 standard deviations above its 50-day moving average. This was the most extreme overbought reading since February 2017. Historically, such powerful readings suggest that a rally is due to pause, not necessarily that the market has to sell off aggressively.

The following table summarizes the performance of the S&P 500 following times when it closed at a record high and more than 2.5 standard deviations above its 50-day moving average. Median returns are modestly lower over the short term but not significantly weaker than average. The magnitude of both gains and losses was smaller than the average maximum three-month gains and losses for all periods since 1945.

Veteran investors have recently echoed that markets don’t move up indefinitely and cautioned investors to put the recent rise into perspective. As Yahoo Finance reports, “The environment for stock picking is ripe for a shift away from passive investing, which could suffer a decade of low or nonexistent returns. ‘This is the single worst time to be a passive investor … since they started passive investments. ... The [S&P 500] index is highly likely to not make money over the next 10 years,’ said Bill Smead, chief investment officer of Smead Capital Management.”

Considering the abnormally high returns that passive investors have made over the past year, an era of low or nonexistent returns is a possibility investors might have to consider. Passive investors experienced such an environment in the early 2000s, as indicated by the period between the two blue horizontal lines in the following chart.

A wealth-management strategy that manages risk first—focusing on preserving wealth and minimizing losses—may be the key to investor success. Each Flexible Plan investment strategy is designed to take advantage of specific observable and measurable opportunities—and avoid specific observable and measurable risks—in the market. When the market enters an environment where those target opportunities and risks are present, the strategy is designed to perform as its profile suggests.

However, the market does change—as do the specific opportunities and risks within it. Because of this, we build portfolios composed of multiple strategies—each one designed to take advantage of different market opportunities and avoid additional market risks. These strategies give the overall portfolio the tools it needs to navigate the market as it changes over time.

Bonds

Treasury yields decreased last week, sending bond prices higher. The 10-year Treasury held below 1.70% to end the week.

The Federal Open Market Committee’s meeting minutes reaffirmed the central bank’s monetary policy last week. Also, Federal Reserve Chair Jerome Powell stated that the U.S. recovery remained “uneven and incomplete” while speaking before the International Monetary Fund (IMF).

The 10-year Treasury has been consolidating over the past month as highlighted in the following chart. For technicians, holding below 1.60% could signal a pullback opportunity in rates. A break above the range would indicate that the move up in rates is likely to continue further. Incorporating tactical bond strategies that can go long and short rates has been critical for investors in such a problematic fixed-income environment.

T. Rowe Price traders reported, “In the primary market, new deals were met with strong demand. Stable rates contributed to favorable technical conditions in the high yield market, and positive flows and manageable issuance also helped.”

Gold

Last week, spot gold closed at $1,743.88, up 0.84%. Gold set a higher low on its previous turn lower and is trying to hold its higher short-term swing high. The yellow metal has been in the middle of a bear price channel as indicated by the two downward-sloping lines in the following chart.

The 50-day moving average (in blue) is the first line of resistance inside this channel. The attempt to set a higher high saw resistance at the 50-day moving average. Maintaining price levels above the 50-day could be a signal for a break out to the upside; however, various resistance levels remain above the current price.

Flexible Plan is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction over eight 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 started last week with a 100% long exposure, went to cash at Monday’s close, and initiated a 40% short exposure at Friday’s close.

Our intermediate-term tactical strategies are uniformly positive, although to various degrees. The Volatility Adjusted NASDAQ (VAN) strategy started last week with 120% long exposure to the NASDAQ, decreased exposure to 100% long at Monday’s close, increased exposure to 120% long at Tuesday’s close, increased exposure to 140% long at Thursday’s close, and increased to 160% long at Friday’s close.

The Systematic Advantage (SA) strategy is 120% exposed to the S&P 500, and our Classic approach is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy was 100% long to start last week. It increased exposure to 200% long at Wednesday’s close, remaining there to end the week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

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 and 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 Falling reading, which favors gold over bonds and then stocks from an annualized return standpoint. The combination has occurred 13% of the time since 2003. It is a stage of above-average returns for gold and bonds but also exhibits higher volatility overall.



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