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 market indexes were down last week. The Dow Jones Industrial Average lost 0.16%, the S&P 500 Index fell 1.21%, the NASDAQ Composite dropped 2.62%, and the Russell 2000 small-capitalization index tumbled 2.9%. The 10-year Treasury bond yield rose 13 basis points to 2.973%, sending bond prices lower for the week. Gold futures closed the week at $1,760, down $55.10 per ounce, or 3.03%.

Stocks

The S&P 500 Index ended its winning streak last week. The Index moved higher until it met the downward-sloping 200-day moving average. It stopped there and has moved lower ever since.

Unfortunately, this is reminiscent of price action in the 2000–2002 and 2007–2008 bear market. In both cases, the Index stall set up a subsequent fall to a new bear market low.

Also noteworthy is that every downturn of the present decline has occurred just after a nasty market pattern. A new short-term high in price was made but on lower volume than the last short-term market low. On August 15, we saw this same price/volume behavior at the top when compared to the low in July.

However, in early August, we did see the Index’s 50-day moving average come to the rescue. It stopped a decline midmonth. Can it do so again? That is the hope of many market watchers. If so, we could be within a percent or two of the end of this down leg.

The 390–395 area of the chart is looking like an area of resistance, as it was also the stopping point of the mid-July decline. If the Index declines significantly below that area, technicians will no doubt be calling for a retest of the mid-June market low.

As we discussed last week, a number of our intermediate-term buy signals fired over the last two months. In the past, these have been very predictive of future market gains. It is one of the reasons why we believe we will not see new market lows this cycle. However, as we also pointed out, the signals are not perfect and are most susceptible to pausing in the first month after the signal is given.

This is especially likely when the market is in overbought territory. Stocks have been on quite a tear since bottoming on June 16. By most measures, they became extremely overbought, suggesting a pause or a reversal in price. We are definitely experiencing the latter.

More than 65% of reported earnings and 69% of sales reports have exceeded analyst expectations, compared to average outperformance in the high 50% range. Bespoke Investment Group suggests that the fact that earnings are outproducing at a lower rate than revenues may indicate inflation is eroding earnings. I note, too, that when this has occurred in the past, stocks have tended to suffer. It occurred in both the 2000–2002 and 2007–2008 bear markets.

About a third of the possible yield-curve inversions are currently signaling a coming recession. Normally, it takes over 50% to make a recession call, but the evidence that we are already there continues to accumulate.

Bottom line: The challenge to the longer-term downtrend and 200-day moving average I spoke of in the August 3 Market Update has now occurred. Stocks were beyond ready for a respite, and that’s just what’s happening. The next week may see a bounce and a return to an assault on new highs or a critical breakdown through the area of support, which could retest the mid-June lows. Given our recent signals, I’m expecting the former. But should the latter occur, I am confident our signals will reverse, as well.

Bonds

Treasury rates have once again reversed course. They bounced as they approached the 200-day moving average and have now surpassed the 50-day moving average that had provided some resistance.

On the back of better economic numbers, rates have moved higher. Bond investors believe the economy’s show of strength gives the Federal Reserve room to continue its aggressive plan to move interest rates higher to kill off inflation fears.

Bond prices have, of course, fallen as they reflect the inverse of the yield movement and direction. The long bond (with a maturity of 20-plus years) is now approaching its lowest level since the Fed’s higher interest rate program was launched. It is down about 35% since its 2021 high.

The high-yield sector of the bond market (junk bonds) continues to track stocks better than rates. It is down, but by less than half of what the long-maturity Treasurys have experienced. As stocks recently rallied, high-yield bonds also rallied. Now with stocks and bonds both hurting, high-yield bonds are falling too. The high-yield bond ETF (HYG) declined 15% at its maximum drawdown. This level could be tested if the decline in one or both of these other markets continues.

Gold

Stronger economic data in the form of better-than-expected numbers of employment and unemployment claims led market participants to expect the Federal Reserve to take a more aggressive stance on interest rates. Rising interest rates can give gold investors pause as it presents a larger lost-opportunity cost.

More importantly, I think, is the renewed rally in the U.S. dollar. This is a bugaboo that the gold market has been suffering with for a good part of this year, and the results are not positive for the yellow metal.

When the dollar had its historic rally earlier this year, gold marched in lockstep lower, rallying only when the dollar showed a bit of weakness. During one such rally at the end of July, I observed that “like gold meeting its resistance at its 50-day moving average, the dollar is likely going to find support at its own 50-day moving average.” From that support, the dollar has indeed rallied, and gold has tumbled.

As the chart above shows, the dollar is rallying again. It has even overtaken its recent high. Normally, that would form some resistance. However, a strong statement by the Fed supporting a continuation of its aggressive rate increase stance could easily launch the dollar to new heights.

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 I watch remain mixed but mostly positive. Our very short-term-oriented QFC S&P Pattern Recognition strategy is 60% invested in the S&P 500 Index.

September is the worst-performing month for the stock market, having fallen on average over the last 20, 50, and 100 years. The QFC Political Seasonality Index (PSI) strategy is currently fully invested and will stay in that allocation until the close on August 24, returning on the close on August 30. It sees September 7 as the likely September top (sell date). The strategy is available separately and is included in our QFC Multi-Strategy Explore portfolio within Special Equities. (Our QFC Political Seasonality Index—with all of the 2022 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 mixed. The Volatility Adjusted NASDAQ (VAN) strategy is 20% inverse to the NASDAQ, the Systematic Advantage (SA) strategy is 60% in equities, Classic is fully invested in equities, and our QFC Self-Adjusting Trend Following (QSTF) strategy is 100% invested in the NASDAQ. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

At the beginning of May, our All-Terrain indicator, one of Flexible Plan’s Market Regime Indicators, registered a major change. Our Growth and Inflation measure began signaling that we were 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 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 has seen larger drawdowns for stocks.

Our S&P 500 volatility regime is registering a High and Falling reading, which favors gold over bonds and then equity from an annualized return standpoint. The combination has occurred 13% of the time since 2003. It is a stage of lower returns for equities and higher volatility for both gold and stocks. The S&P 500 registered a maximum drawdown of over 29% during one of these regimes, while gold’s maximum price loss was over 21%.



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