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 Jerry Wagner

The major U.S. stock market indexes finished down for the third week in a row. The Dow Jones Industrial Average lost 2.4%, the S&P 500 Index fell 3.2%, the NASDAQ Composite dropped 3.9%, and the Russell 2000 small-capitalization index gave back 4.0%. The 10-year Treasury bond yield rose 1 basis point to 2.913%, sending bond prices lower for the week. In fact, the long-term Treasury bond ETF (TLT) fell 0.5% last week. Gold futures closed at $1,891.30, down $43.00 per ounce, or 2.22%.

Raging inflation, an interest-rate-tightening Federal Reserve, and the Ukraine invasion have tightened their grips on investor psyches. Both the S&P 500 (-13.3%) and the NASDAQ Composite (-21.2%) have registered their worst performance in the first four months of a year since the 1930s. More than half of these losses occurred in April.

All but one of the S&P 500 sectors (Consumer Staples) fell during the month. All of the equity style boxes suffered monthly losses of 5.1% (S&P 500 Value) to 12.6% (S&P 500 Growth). It was no different in overseas stock markets. Both the developed (EFA) and emerging markets (EEM) country ETFs saw more than 6% losses in April, and drops of about 13% for the year to date.

Back in the U.S., an underlying cause of our equity market sell-off was becoming more apparent as the year progressed. When the March economic reports were published in April, the extent of the economic weakness here was made clear: The gross domestic product (GDP) figure for the first quarter fell for the first time since 2014 (apart from quarters with pandemic lockdowns). In addition, the count of economic indicators with year-over-year performance and the number beating economist consensus predictions turned negative.

March housing and manufacturing reports were negative versus February’s, inflation measures were almost uniformly rising, the University of Michigan Consumer Sentiment Index fell over 30%, and auto sales tanked 25%. Year over year, personal spending was less than February’s increase, while personal income sank over 11%. Declines in personal income almost always precede recessions, and this decline was the worst on record.

Talk of recession was already plentiful, spurred on by the inversion (when short-term maturities in the Treasury bond market start to yield more than longer-term maturities) of some of the 50-odd yield curves. As I pointed out in a previous market update, it is especially concerning when a majority of these curves invert. So far, only three of the curves have done so. And while none of the maturities that have a perfect record of calling recessions within two years has triggered, two of the three that have triggered have been right over 90% of the time.

Finally, the NASDAQ bottom-finder indicator, based on the percentage of stocks making new highs, has reversed back below the 20% level. As a result, it is still a considerable distance from the 35% level that would signal that the worst is over.

Bottom line: The price action Friday (April 29), with most of the indexes breaking below their recent lows (see red line on the S&P chart above), seems to be signaling that the downturn is not over. However, the severity of the downward thrust Friday is likely to bring a mean-reversion, contrarian bounce to stocks in the short term (three–five days).

Bonds

In the face of rampant inflation and a more hawkish Federal Reserve, interest rates have been soaring. Back in August, the yield was 0.5%, or 50 basis points (bps). Last week, the yield closed at almost 3%. As the above chart demonstrates, yields have clearly broken out above their recent highs, and declines in the rates quick ascension have been shallow, of the 20-to-30-bps variety.

Of course, mortgage rates have soared, hitting 5.5% last week according to Bankrate.com. This puts added pressure on the economy and is the primary reason the housing industry has slowed. In the meantime, bondholders have suffered mightily. Whether invested in the security of Treasury bonds or those high-flying, high-yielding junk bonds, investors have seen nothing but losses since the end of last summer.

Gold

Gold has been one of the bright spots in the financial markets this year. Its ability to diversify investor portfolios is the big reason we make it available for use in so many of our portfolios. It tends to move in the opposite direction of the stock market at key crisis points.

But rising interest rates and a soaring dollar have reversed gold’s bull-market price rise. Last week, gold sliced below its 50-day moving average, which will put added technical pressure on prices.

Gold usually moves in the opposite direction of the dollar. As is clear from the chart below, the dollar has been soaring since its early-March breakout. However, the ascent has become almost parabolic, turning its price line almost straight up. This is not sustainable, and a flattening out or pause in the dollar’s advance would not be surprising.

Flexible Plan Investments (FPI) 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

The short-term-trend indicators for stocks that we watch are negative. However, very short (three–five day) patterns suggest a bounce. Our very short-term-oriented QFC S&P Pattern Recognition strategy has now exited stocks.

Our Political Seasonality Index has been in the market since the close on April 28 and will stay there until the market close on May 9. Through Friday, it has gained over 2% this year. The strategy is included in our QFC Multi-Strategy Explore portfolio within Special Equities and mostly uses our sub-advised Quantified Common Ground Fund (QCGDX) for equity market exposure. (Our QFC Political Seasonality Index—with all of the daily signals—is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.)

FPI’s intermediate-term tactical strategies are very mixed. The Volatility Adjusted NASDAQ (VAN) strategy has a -30% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 60% exposed to the S&P 500, and our QFC Self-Adjusting Trend Following (QSTF) strategy has an exposure of 0% (as of the close on April 25). VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic strategy has been invested in stocks since the close on April 5. QFC Classic has been principally invested in our popular Quantified Common Ground Fund (QCGDX), allowing the strategy to outperform the S&P since purchase. On May 3, 2022, Classic generated a sell signal and a move into defensive asset classes. Due to platform limitations, a few products may have to hold off selling until a required minimum hold has been registered.

Among the Flexile Plan Market Regime Indicators, there was a major change. Our Growth and Inflation measure shows that we are now in a Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative monthly GDP reading).

This occurs only about 9% of the time and favors gold (but see discussion above on the current impact of the dollar on gold prices) and then bonds over stocks. It is a time of moderate risk for gold, but stocks have their second-worst drawdown of all the regimes. Only the Deflation economic environment stage has seen lower drawdowns for stocks. The last time we saw this condition was in the late 1970s and early 1980s, when substantial shrinkage of the Case/Shiller P/E occurred, driving the ratio down to as low as 7 times earnings.

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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