Market insights and analysis

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

2nd 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 Jerry Wagner

The major U.S. stock market indexes finished generally higher last week. The Dow Jones Industrial Average gained 0.2%, the S&P 500 Index rose 0.4%, the NASDAQ Composite also climbed 0.4%, and the Russell 2000 small-capitalization index—the lone loser—dropped 1.1%. The 10-year Treasury bond yield fell 6 basis points to 1.36%, boosting bond prices for the week. Spot gold closed at $1,808.32, up $21.02 per ounce, or 1.18%. 

Stocks

Earnings reporting season begins this week. This six-week period does not encompass all earnings releases (for example, Levi Strauss reported last week). But most U.S. firms will be reporting their second-quarter earnings and revenue gains or losses beginning this week.

As the chart above illustrates, these revision periods have mostly seen higher prices of late. In fact, the last seven have seen prices rise in value—tying a record—although the last three have seen periods of volatility.

Historically, earnings revisions by analysts in the weeks preceding the reporting season have given a good prediction of the market response to the reports to come. If the revisions were negative on balance, then the market tended to move higher as stocks had a lower hurdle to overcome. If revisions were generally positive, results were negative.

Recently, it has been found that very high levels of positive earnings revisions, as is the case now, contradict the previous history and have shown positive results. This was the case last quarter, for example. In fact, according to the Bespoke Investment Group, four out of five times when the revisions topped an average of 15%, the S&P 500 gained ground (average 1.23%) during earnings season.

Not only are earnings revisions important but earnings growth is an essential tool for determining market direction. As the chart below demonstrates, the market almost perfectly reflects the growth in earnings.

In the first quarter, earnings snapped back and so did the S&P 500. Currently, FactSet, a financial data and software firm, says the consensus analyst expectations are for a 7.3% rise in earnings by the time the reporting season is finished. Although FactSet has only been tracking this number since 2002, it is noteworthy that this quarter’s rise is the greatest increase ever recorded. Attainment of this mark, when the actual numbers are reported, may be enough in and of itself to send the Index still higher this year.

Not many economic indicators were reported on last week. Most reports, like those on the service sector (ISM Services PMI), failed to live up to economists’ expectations. The 60.1% reported as the May Services PMI level, for example, fell from the previous month’s record 64% and was below analysts’ consensus predictions of 63.5%.

Despite the new highs registered on many markets last Friday (July 9), small investors continue to have mixed views on stocks. Their bullish sentiment is just at middle-of-the-road levels. Perhaps more telling is the current reading on their bearish expectations. As the next chart discloses, these are at very low levels that have often led to falling equity prices in the past.

With the S&P very overbought, the stock market seems to be propelled higher on a technical basis only by its own momentum. While less than 60% of the S&P 500 is above its 50-day moving average, there still have been 80 stocks in the Index that gained more than 10% since the May 12 market lows.

Bonds

While both government and high-yield bonds bottomed in mid-March, the latter gave a 50-day-moving-average breakout buy signal soon after. The government bond ETF did not send its own buy signal until early June.

Although the gains of late have been substantial, Friday (July 9) saw a big retracement. In fact, the yield on the 10-year bond plunged below its 200-day moving average on Tuesday (July 6), before bouncing back above it on Thursday (July 8). Typically, the 200-day measure will resist further declines in yield. However, with the 10 year yielding 1.36%, down from 1.75% just three months ago, commentators are foretelling a continued downtrend in yields, possibly to 1.25% or lower before year-end.

In addition, according to the CME Group’s FedWatch Tool, there’s a 75% probability that interest rates will stay in the range of 0.00% to 0.25% a year from now.

Gold

Gold prices continued to move higher. In doing so, they set off a “golden cross” buy signal. This happens when the shorter 50-day moving average of gold prices exceeds the longer-term 200-day moving average. Historically, this has signaled an opportune time to buy gold.

The interest rate reduction discussed above makes gold more attractive due to a lower cost to carry. This is especially true when inflation expectations continue to soar as they have this year.

Data in the New York Federal Reserve Survey of Consumer Expectations released this week supports this. The median one-year inflation expectations of consumers soared higher along with the actual inflation numbers for April.

Gold may get another boost if the government’s inflation report, released later this week, contradicts the current expectations of a lower reported consumer price index (CPI) (4.9% consensus prediction versus 5% actual last month).

Flexible Plan is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction 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 mixed but stronger overall. Our Political Seasonality Index remains on a buy signal until the close of the market on July 14. Then we go through a choppy period of on-again, off-again signals until a new longer-term buy signal occurs on August 9. (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.)

Our very short-term-oriented QFC S&P Pattern Recognition strategy remains at a -0.5X reading, meaning it is 50% short against the price movements of the S&P 500 Index.

FPI’s intermediate-term tactical strategies are uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy has a 180% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 140% exposed to the S&P 500, our Classic strategy is in a fully invested position, and our QFC Self-adjusting Trend Following (QSTF) strategy has an exposure of 200% invested. VAN, SA, and QSTF 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 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.

Our Volatility composite (gold, bond, and stock market) has a Low and Falling reading, which is the most favorable regime stage for stock returns historically, followed by gold and then bonds. This stage occurs about 37% of the time.



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