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 Tim Hanna

The major U.S. stock market indexes were mostly up last week. The S&P 500 increased by 0.06%, the Dow Jones Industrial Average lost 0.12%, the NASDAQ Composite was up 0.65%, and the Russell 2000 small-capitalization index gained 0.63%. The 10-year Treasury bond yield fell 9 basis points to 2.38%, taking Treasury bonds higher for the week. Spot gold closed the week at $1,925.68, down 1.67%.

Stocks

Momentum in stocks continued the first two days of last week, even as the spread between the two-year and 10-year Treasurys inverted on Tuesday. Markets pulled back the rest of the week as little progress was made in talks between Ukraine and Russia. Last week also marked quarter-end rebalancing and possibly profit-taking considering the recent moves up in the markets. Multiple risks continue to weigh on investors’ minds going into Q2.

On the economic data front, the core personal consumption expenditures (PCE) price index was within the anticipated 0.5% for February, its highest level since 1983. Unemployment claims reached 202,000, slightly worse than the expected 195,000. Non-farm employment change came in at 431,000, below the 492,000 that was forecast. The unemployment rate registered at 3.6% on Friday, better than the expected 3.7%. Average hourly earnings month over month were in line with the 0.4% that was forecast. The ISM’s Manufacturing PMI reached 57.1, slightly below expectations of 58.9.

The S&P 500 continues to trade above its 200-day moving average. If momentum continues, the “death cross” (when the 50-day moving average crosses below the 200-day moving average) could be short-lived and a “golden cross” (when the 50-day moving average crosses above the 200-day moving average) could be triggered. The S&P 500 is now trading in the top half of its 2022 peak-to-trough price range. The NASDAQ Composite is currently trading in between its 50-day and 200-day moving averages.


Markets closed out the first quarter in a wild ride last week. After trading to a record high to start the year, the S&P 500 fell 13% to its low in early March and then rallied 11% from its quarter low to its quarter high a few days before the end of the quarter. Bespoke Investment Group studied quarters when markets had movements of 10% down from a quarter high and then traded 10% or more above the quarter’s low.

These types of moves within a quarter are rare. The S&P 500 has had such price movements in only 11 other quarters post World War II. Of those 11 periods, the S&P 500 finished the quarter higher only three times. Historically, the median decline is much worse than the 4.9% loss that investors experienced this year. The median loss over the period studied is 11.7%, while the average loss is 10.6%.

The S&P 500 performed consistently to the upside one quarter and one year forward. The next quarter, the Index was higher 10 out of 11 times. Looking out a year, the S&P 500 was higher all 11 times.

Another notable characteristic of the first quarter was extreme volatility in day-to-day moves. The average daily change in Q1 was 1.11%, ranking 26th of all quarters since 1945.

The percentage of total days in the first quarter with an absolute change greater than or equal to 1% ranked 15th of all quarters since 1945. Bespoke believes this implies uncertainty within the markets, as sentiment shifts resulted in wild daily swings.

Of all of the up days in the first quarter, 56% gained at least 1%. This ties for the sixth-highest quarterly percentage since 1945.

When looking at the flip side of the above, 46% of the total down days in Q1 lost over 1%. This was higher than average but ranks 26th among the quarters since 1945.

Bespoke screened for quarters with the highest percentage of trading days in which the S&P 500 moved 1% or more on a daily basis. It also screened for quarters with the highest percentage of days with absolute returns of 1% or more. Fourteen quarters met both criteria. Performance during those quarters is very similar to Q1 of this year. The S&P 500 gained less than half of the time and experienced a median decline of 3.7%.

Forward returns out of such quarters are generally strong. The S&P 500 averaged a gain of 6.3% (median is 8.8%) with positive returns experienced more than 75% of the time, almost triple the average of all quarters since the start of 1945. Following these quarters, the S&P 500 averaged a gain of 22.7% (median is 23.5%) and was positive in all except Q3 2008, when the Index dropped another 9.4%.

The forward return “ride” investors will experience this time is difficult to predict. Markets face many risk factors now that aren’t represented within all historical periods studied. For example, investors are now contending with the uncertainty surrounding Russia and the war in Ukraine, inflation that hasn’t been experienced in almost 50 years, and a Federal Reserve that is in a rate-hike cycle, just to name a few. In times of uncertainty, active, risk-managed strategies are critical to helping manage losses and avoid deep drawdowns.

Traditional asset-class diversification failed investors in the beginning of the quarter as the S&P 500 fell almost 14% and the NASDAQ lost over 20%. As the stock market retraced, losses in traditional bond exposures were further magnified. To put this relationship into perspective, the S&P 500 and the Bloomberg Barclays Aggregate Bond Index were both down around 5% for the first quarter this year. 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 on the 10-year Treasury fell 9 basis points, ending last week at 2.38% as the bond market suffered its worst quarter since 1980. Portions of the yield curve inverted last week, the most watched being the two-year and 10-year inversion. Historical examples show that recessions occur within six months to two years following inversion.

Investors look to be favoring longer-dated Treasurys, possibly due to signals that the Federal Reserve may hike rates by 50 basis points in May. The 10-year Treasury continues to trade above its one-year-high breakout level (see the black horizontal line in the following chart) and experienced shallow pullbacks since the start of the move in March. Following an easy breakout at the 2% level, technicians are seeing wide-open space above, with the 3% level last seen in late 2018.

T. Rowe Price traders reported, “More volatile credits outpaced the broader market, and credit spreads … moved wider. … Technical conditions were mixed as healthy trading volumes were countered by higher-than-expected levels of new issuance. … The high yield market saw better-than-average trade volumes as investors appeared to be encouraged by the potential positive headlines out of Ukraine and looked for deals in the secondary market. New issuance remained muted.”

Gold

Last week, gold fell 1.67%, pausing its upward momentum following the February breakout (see the black line in the following chart) as the yellow metal remains right above its 50-day moving average. Price action appears to show that gold is finding support at levels above the 2021 price range as geopolitical tensions, inflation fears, yield-curve inversion (recession fears), and Fed rate hikes continue to make a case for gold into 2022.

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 started the week with 0% exposure, changed to 80% long at Thursday’s close, and changed to 160% long at Friday’s close. Our QFC Political Seasonality Index favored defensive positioning throughout most of last week, trading back into stocks at Thursday’s close. (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 less defensive positioning. 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 and changed to 20% short at Tuesday’s close. The Systematic Advantage (SA) strategy is 0% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 0% exposed until Friday’s close when it initiated a 100% long 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. On Tuesday’s close (April 5), Classic moved back into stock investments. 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. However, many market gurus are now suggesting that the U.S. could soon be moving into a stagflation phase (rising inflation and declining GDP). This would materially change the expected performance of all of the asset classes.

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 higher returns and lower volatility for bonds relative to the other volatility regimes.



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