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 Tim Hanna

The major U.S. stock market indexes were up last week. The S&P 500 increased by 2.55%, the Dow Jones Industrial Average gained 1.95%, the NASDAQ Composite was up 3.33%, and the Russell 2000 small-capitalization index rose 3.58%. The 10-year Treasury bond yield fell 16 basis points to 2.75%, taking Treasury bonds higher for the week. Spot gold closed the week at $1,727.64, up 1.14%.

Stocks

Equity markets rose last week, even as data and headlines continued to suggest a slower growth environment. On Tuesday, the Bank of America Global Fund Manager Survey revealed that funds had the lowest equity exposure since the 2008 financial crisis and the highest cash holdings since 2001. The move up last week seems to have been supported by potentially unsustainable negative sentiment levels, short covering, and a contrarian market view.

On the economic data front, the July National Association of Home Builders/Wells Fargo Housing Market Index came in at 55, worse than expectations of 66. Other than the COVID-related decline in April 2020, this was the biggest monthly drop for the Index on record. June housing starts were 1.56 million, slightly below expectations of 1.57 million. Existing home sales registered at 5.12 million, worse than the 5.37 million expected.

The Philadelphia Fed Manufacturing Index fell to -12.3, lower than the 0.9 forecast. Values above 0 indicate improving conditions, while values below 0 indicate worsening conditions. Unemployment claims reached 251,000, marginally worse than the expected 240,000. The Flash Manufacturing PMI registered at 52.3, slightly above the expected 52.0. The Flash Services PMI was 47.0, less than the anticipated 52.6.

In addition to digesting earnings and fundamentals, investors are also assessing technicals and sentiment as they await news about the federal funds rate and advance GDP this week. Most significant from a technical perspective is the S&P 500’s trading activity above its 50-day moving average. Bespoke Investment Group reported that after nearly three months of trading below its 50-day moving average and successive lower highs, the recent rally broke the downtrend from the late-first-quarter high and is back above its 50-day moving average.

While last week’s rally did push the S&P 500 above its 50-day moving average, volatility remains elevated, and moves in both directions continue to be above average since the low in June. Price remains around the midpoint of a bearish channel, as the S&P 500 now trades between its 50-day and 200-day moving averages.

While the higher high and higher low since the June low is encouraging, the Index remains well below its 200-day moving average and the downtrend from the January high. Worth noting is that the late-first-quarter rally that also made a higher low and higher high (the first black rectangle in the chart above) failed to hold, and the markets made new lows within weeks.

Considered to be one of the most important groups in the market, the Philadelphia Semiconductor Index (SOX) also moved north of its 50-day moving average. SOX hasn’t followed through much on breaks above its 50-day moving average over the past year, reversing course quickly to make new lows both times it broke above the 50-day moving average in the last 12 months.

On a relative-strength basis, semiconductors have outperformed during the rally off June lows but remain in well-defined short-term and long-term downtrends. Based on the sector’s performance, little suggests a major bull rally is in play.

The S&P 500 recently logged a 60-day streak of closes below its 50-day moving average, the longest streak since December 2008, going back to the end of World War II. It is the 31st streak of 50 or more trading days below the 50-day moving average.

While there was plenty of news for and against the significance of that technical occurrence, Bespoke Investment Group studied the historical data. The firm looked at all periods since WWII where the S&P 500 traded below its 50-day for at least 50 days and then calculated the performance of the Index after the streak was broken. Of the 30 prior periods (light blue bars in the following chart), forward returns were mixed relative to the long-term average for all periods (dark blue bars in the following chart). Median returns were slightly better than average for all periods over the following week and month. Over the next three and six months, median returns were lower than average and less consistently to the upside. One year later, the median return (+13.53%) was above the average for all periods (8.93%); however, the consistency of positive returns was lower (63.3% versus 73.4%).

None of the streaks show a consistent pattern relative to long-term average returns after the streak’s end. However, when you compare streaks with similar ends to the current streak, something interesting presents itself: They end with a 2%-plus surge in the Index. The gray bars in the charts above summarize the returns following such periods. Of the 30 prior streaks, 10 ended with the S&P 500 surging more than 2% on the day the streak ended.

If you include this additional criterion, a much more consistent trend of outperformance relative to historical averages appears. Over the following week, month, three months, six months, and one year, the Index’s median performance has been better than the long-term average for all periods. Only the three-month time frame resulted in lower consistency of positive returns.

The S&P 500 finally broke its recent streak of time below its 50-day moving average. It has also been over three months since the Index has traded at overbought levels (greater than one standard deviation above the 50-day moving average). This is the longest streak since 2019 and could become the longest streak since the financial crisis if the Index does not close at an overbought level this week. The longest streak since the late 1980s was a 160-trading-day streak that ended November 4, 2002.

With so much uncertainty around the sustainability of this rally, it’s more important than ever to invest in active, risk-managed strategies that are able to respond to changing market conditions. With the continued disconnect between fundamentals and technicals, it’s critical to respond to price movements as they come, rather than trying to predict them based on news and emotions.

If prices continue to move up and volatility is low, systematic trend-following algorithms are designed to recognize the price momentum and participate in a risk-on fashion. If this is a head fake and prices reverse direction, systematic momentum strategies are designed to identify the change and move to or remain in defensive positioning.

The following chart shows the year-to-date performance of the Quantified Managed Income Fund (QBDSX, -0.9%) compared to the iShares Core US Aggregate Bond ETF (AGG, -9.1%). 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 16 basis points, ending last week at 2.75% as the bond market continues to get relief during its battle with rising interest rates. The 10-year Treasury remains within the pullback that started mid-June and is now below its 50-day moving average.

Major pullbacks this year have resulted in short-term “bull flags” (the black lines on the following chart) that eventually break out to the upside. Such price patterns are considered continuation patterns, with breakouts targeting new highs and a continuation of the longer-term trend. The price structure is not currently suggesting a longer-term reversal, but trading activity below the 50-day moving average could signal a deeper pullback than we’ve experienced this year. Technicians are looking for a lower high or a failed break of highs to suggest a possible formation of a downtrend. Investors are eagerly awaiting the Federal Reserve’s rate decision and statement this week, which could guide the next leg’s direction in the bond market.

T. Rowe Price traders reported, “Despite the uptick in supply, corporate credit spreads tightened alongside improved macro sentiment. … High yield bonds traded higher along with equities amid the somewhat more stable macro backdrop. … Broader risk markets were focused on earnings results and the European Central Bank’s (ECB) first rate hike in 11 years ahead of next week’s U.S. Federal Reserve monetary policy meeting.”

Gold

Last week, gold gained 1.14% but ended the week trading well below its 200-day moving average following the metal’s collapse at the beginning of July. The drop came after multiple attempts to hold above its 200-day moving average in May and June. The downward price movement has set a one-year low for the yellow metal.

The U.S. dollar’s break to new highs (the purple line in the following chart) hurt gold. A higher dollar is a restraint on global liquidity and a headwind for inflation in the U.S. In general, a stronger dollar lowers the price of imports. The U.S. dollar and other non-equity or bond exposures are available asset classes for consideration within certain strategies at Flexible Plan Investments.

Although gold has struggled since late April as the U.S. dollar has marched higher, geopolitical tensions, recession fears, and the impact of Fed rate hikes continue to make a fundamental case for gold into 2022. Gold may see some upward movement due to mean reversion, especially if we see sustained weakening in the U.S. dollar over the coming months.

Flexible Plan Investments is the subadviser 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 very short-term-oriented QFC S&P Pattern Recognition strategy started the week 70% long, changed to 40% long at Tuesday’s close, changed to 0% exposed at Wednesday’s close, and changed to 10% short (negative) at Thursday’s close where it remained to end the week. Our QFC Political Seasonality Index favored stocks the first part of last week and changed to defensive positioning at Wednesday’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 varied in their degree of 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 20% short the NASDAQ throughout last week, changing to 40% short at Friday’s close. The Systematic Advantage (SA) strategy is 60% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy started the week 100% short, changed to 0% exposed at Tuesday’s close, and changed to 100% long at Thursday’s close. 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, although it will buy back into its usual equity positions on Tuesday’s (7/27/22) close. 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.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, shows that we continue to be in the Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative quarterly GDP reading). This environment has occurred only 9% of the time since 2003 and favors gold and bonds, while equities tend to fall. Gold has significantly outpaced both stocks and bonds on an annualized return basis in this environment, with a lower risk of drawdown than equities. From a risk-adjusted perspective, Stagflation is also one of the best stages for gold.

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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