Market insights and analysis

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

3rd 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.

The major stock market indexes finished up again this week (the S&P 500 has gained more than 3% for three straight weeks). The Dow Jones Industrial Average gained 6.8%, the S&P 500 Index rose 4.9%, the NASDAQ Composite climbed 3.4%, and the Russell 2000 small-capitalization index rocketed 8.1%. The 10-year Treasury bond yield rose 24 basis point, as Treasury bonds tumbled. Last week, spot gold closed at $1,684.38, down $45.89 per ounce, or 2.65%.

Stocks

The S&P 500’s breakout above its 200-day moving average two weeks ago continues to push it higher. But the 500 stocks of the S&P are not the only issues prospering in the current market rally. The gains have been broad-based, as evidenced by the matching move higher by the cumulative advance-decline line in the preceding graph.

Similarly, the level of breadth has been very encouraging. Most stocks are participating in the move higher. When we have the kind of bullish thrust in breadth (stocks advancing in multiples versus those declining) that we have had in the last week (including Friday), it has led to further advances over all future time periods up to one year in advance a very high percentage of the time.

As a result, I remain confident that we will see new index record highs this month barring some significant negative news item. Since I first voiced this opinion, we have already seen new highs reached on the NASDAQ Composite. Can the Dow and S&P 500 be far behind?

By the way, one reason the NASDAQ reached new heights first is that it fell less than these other indexes in the COVID-inspired February 19–March 23 drop in stock prices. Such is the power of the mathematics of losses. If your investment falls less than others, it can recover more quickly. Hence, reducing losses is our top priority.

Over the last 100 years, seasonality has been favorable for stocks in June, although not so much in the last 20 years. Our Political Seasonality Index is positive through June 12. A decline through June 30 is then forecast, so those new highs seem more likely to occur in the first half of the month. (Our Political Seasonality Index is available post-login in our Solution Selector under the Domestic Tactical Equity category.)

Bonds

As the economy shows signs of reopening, and as the Federal Reserve Balance Sheet continues to grow with Fed purchases of bonds and ETFs (although at a slower rate lately), interest rates have stopped falling and are actually moving higher once more. Of course, that means that the price rise in bonds seems to have topped out, at least in the short term.

As I suggested might happen in last week’s Market Update, the popular 7-10 year Treasury bond ETF (IEF) dropped below its 50-day moving average. This has not happened in 2020. In response, the bond ETF slipped 1.7%, while the 20-30 year Treasury bond ETF (TLT) fell 4.5%

Our popular Government Income Tactical (GIT) and QFC Fixed Income Tactical (QFIT) strategies have had very little exposure to government bonds the last few weeks. QFIT did benefit due to its exposure to high-yield bonds, which finished the week higher.

The interplay between the use of high-yield bonds and government bonds during rising-rate environments will be discussed in detail in our “Fixed-Income Strategies for Today’s Markets” webinar at 4 p.m. EDT on June 9. You can register here to view the live presentation or to receive access to the recording (for financial professionals only).

Gold

Gold, like government bonds, breached its 50-day moving average last week. Risk-on conditions supporting stocks have returned, and these “flight to safety” darlings have been out of favor. Gold registered its worst one-day decline since the end of March, falling 2.5% as stocks staged their huge rally Friday with the news of a sharp reversal in the number of new jobs.

Gold fell despite the plunge in the U.S. dollar since March 23. Normally, a falling dollar is bullish for gold, and it was during March and April. However, once we moved into May, gold’s advance stalled. Perhaps a continued decline in the dollar (now down 6.24% on the Bloomberg Dollar Index) will help gold ward off the effects of its breakdown through its 50-day moving average.

Economic news

Speaking of Friday’s unemployment report, it was an amazing turnaround in an economy seemingly in decline within the grip of the current pandemic. Another 7.5 million jobs were expected to be lost, according to economist forecasts. But when the Department of Labor’s report was published, we learned that 2.5 million jobs had actually been created! Instead of a 20% unemployment rate, we were looking at 13%, which is still horrid but certainly better than expected!

The turnaround was confirmed by a number of other economic measures. Both the ISM Manufacturing and Services reports staged a month-over-month rebound, as did all of the Purchasing Manager Indexes (PMI) reported last week from around the world. While all of these measures remain in contraction rather than expansion mode, the monthly rebound was an encouraging sign as the world economies struggle to reopen.

The indicators

With the near-term outlook for flight-to-safety investments such as bonds and gold looking weak, the short-term trend indicators we monitor for stocks remain positive. However, the very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure remains at 0%, perhaps cautious in the face of overbought and very optimistic market sentiments by many.

Whenever we are near, or creating, new highs, we are also likely overbought. However, there are two types of overbought markets: those that struggle as they near an overbought reading and those that accelerate through that level. The former quickly see prices reverse, while the latter tend to see a more prolonged advance.

Today, most measures are telling us that we are in the favorable overbought condition. Since 1952, the last time we had a 40% move in just 50 days, 20% or greater moves in the S&P 500 in that number of days have always led to gains (usually double-digit gains) over the next six months. And when the Index has exceeded its 50-day moving average by more than 10%, as is currently the case, the market has almost always moved higher over the next one-, three-, six-, and 12-month periods, with just a couple of losses at the one- and three-month breaks.

Our intermediate-term tactical strategies are uniformly positive, although to various degrees. The Volatility Adjusted NASDAQ (VAN) strategy has an 80% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 112.5% exposed to the S&P 500, our Classic strategy is in a fully invested position, and our Self-adjusting Trend Following (STF) strategy remains 200% invested. VAN, SA, and STF can all employ leverage—hence the investment positions may at times be more than 100%.

Among the Flexible Plan Market Regime indicators, our Growth and Inflation measure shows that we are now in a Deflation economic environment stage (meaning a negative monthly change in the inflation rate and negative monthly GDP reading). Two weeks ago, the Commerce Department reported that the GDP fell at a 5% annual rate in the first quarter. One month ago, the first estimate reported was -4.8%.

Deflation is the worst regime stage for stocks and the only stage that is slightly negative for gold. Bonds seem to do the best in this stage. Since 1972, the economy has been in a Deflation stage only 3% of the time. Given the unusual impact of the virus on the economy, history may be less of a guide this time. We shall see.

Our Volatility composite (gold, bond, and stock market) is still showing a High and Falling reading, which favors gold over bonds and then stocks, although all have positive returns in this regime stage.

All of us here at FPI wish you and your families health and safety in these trying times,

Jerry



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