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 were generally lower last week. The Dow Jones Industrial Average lost 0.4%, the S&P 500 Index also fell 0.4%, the NASDAQ Composite gave up 1.1%, and the Russell 2000 small-capitalization index—the lone gainer—picked up 0.75%. The 10-year Treasury bond yield fell 5 basis points to 1.22%, boosting bond prices for the week. Spot gold closed the week at $1,814.19, up $12.04 per ounce, or 0.67%. 

Stocks

New highs were registered by both the S&P 500 and NASDAQ 100 indexes last week. In addition, July marked the sixth month in a row of monthly gains.

Both of these conditions suggest a continuation of the bull market. Historically, gains are usually obtained over the short and intermediate term following such events. While that occurs a high percentage of the time, the funny thing about probability is that there is always an inverse percentage of the time when the investor is disappointed. A 75% probability of success is not a 100% guarantee—there is still a 25% possibility that a decline will ensue.

Could this be one of those times?

We are entering a period of some uncertainty. As the chart of the S&P 500 above suggests, the market is in overbought territory. And we know that on a valuation basis stocks are also in the overpriced zone.

Economic indicators like the new homes sales figures released last week (down 6.6% versus May and down 19.4% versus June 2020) continue to disappoint. While July’s consumer confidence index was encouraging, registering the highest reading since pre-pandemic January 2020, enough macroeconomic indicators have softened to cause SentimenTrader’s Macro Index indicator, which follows the trends in reports on the economy, to move to a sell signal. This joins its Yield Curve indicator in the sell column.

In addition, as we move into August, the odds of a continuation of market gains are reduced. Over the last 50 years, August is the second-weakest month of the year (following September) and the fourth-worst month in the last 20. And historically in a year following a presidential election year, the stock market has been especially weak in the August–October period.

So why we are still invested? Again, probabilities. Right now the technical underpinnings of the market (principally solid trend and momentum readings) remain strong. We have seen some softness in the market breadth but overall technical conditions continue to support the bullish posture of our models. For example, the Market Leaders’ Market Environmental Indicator (MEI) remains positive, although it is at its lowest level since the strategy leveraged into stocks following the pandemic.

These robust technical indicators are supported by continual surprises to the upside as the second-quarter earnings season progresses. At the season’s midpoint, we find that over 77% of earnings and revenue reports have been better than market analysts’ projections. And forward guidance from the companies has been exceptionally strong.

This week brings the highest number of firms reporting, and if this high “beat” percentage persists it could continue to propel the market indexes higher at least this week. The direction of stocks tends to follow earnings growth. As a result, we could begin and end the month on the upside (stocks tend to increase during the last week in August before a September slide) with most of the August damage coming midmonth.

The rise of the delta variant has begun to increase COVID cases and fears, which can translate into market uncertainty. This may manifest itself as further pressure on stock prices in August. Yet results in the largest study of the variant (more than 229,000 subjects in the U.K. since February 1, 2021) demonstrated that, at least in a country with high vaccination rates, the severity of the variant is much lower (deaths about 90% lower than original COVID).

And in this country, with nearly as many vaccinated (50% versus 57% fully vaccinated), the variant has yet to have a significant impact on the daily rate of death from the virus, as well. In addition, the “herd immunity” data we discussed here continues to show 15 countries (including the U.S.) at the RO 3 level of herd immunity (four at the RO 4 level). In addition, 28 of the 50 states have achieved herd immunity at that level (eight at the RO 4 level).

Bonds

While both the government and high-yield bond ETFs 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 July gains have been substantial, last week both bond ETFs failed to make a new high for July. Bonds are still smarting from the tumble they took in early July just after a new short-term high had been established. Our Fixed Income Tactical and Government Income Tactical strategies have now eliminated their government bond exposure and initiated some inverse exposure instead.

Bonds gained ground in July’s final week, as the Federal Reserve assured investors that no change in policy was imminent. While Fed open market purchases declined $18 million, that appears to be a normal end-of-the-month adjustment and not an indication of a strategy modification.

The Fed’s preferred inflation gauge remained at the 4% level for June. This is more than 1.4% below the consumer price index annual rate of change. Although it is lower, a review of the chart of the personal consumption expenditures rate shows inflation to be increasing substantially. This will continue to put pressure on the bullish bond case.

Gold

Gold moved higher last week in response to the inflation concerns noted above, as well as the lower interest rate environment that reduces the perceived cost to carry gold in one’s portfolio. The combination of these effects is to pull the real yield of bonds to a new low of -1.2% (the 10-year government-bond yield less the rate of inflation).

As one can see from the chart above, gold thrives in a financial marketplace with lower real yields. The relationship is not perfect, but in periods when real yield is declining, gold prices generally tend to move higher.

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 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. Our Political Seasonality Index is going 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 2X reading, meaning it is 200% long 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 140% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 120% 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 High and Rising reading, with stock returns historically outpacing gold and then bonds. This stage occurs about 23% of the time and contains the worst declines for the stock market, so caution is advised.



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