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 Tim Hanna

Major U.S. stock market indexes were down last week. The S&P 500 decreased by 0.59%, the Dow Jones Industrial Average was down 1.11%, the NASDAQ Composite declined by 0.73%, and the Russell 2000 small-capitalization index lost 2.50%. The 10-year Treasury bond yield fell 2 basis points to 1.26%, taking Treasury bonds higher for the week. Spot gold closed at $1,781.11, up 0.08%.

Stocks

The markets touched record highs but ended the week lower following various developments: The Russell 2000 Index briefly fell into correction territory, down over 10% since its March 2021 peak. The delta variant appeared to worsen supply chain disruptions and the Federal Reserve’s timeline for tapering sooner than later continued to concern the markets. Additionally, global uncertainty related to the Taliban taking control of Afghanistan following the U.S.’s exit and worries regarding vaccine efficacy contributed to investors’ worries last week.

As investors were troubled that growth may be peaking, economic data, although mixed, seemed to mostly add to the negative sentiment. Retail sales fell more than expected, coming in at -1.1%, below expectations of -0.2%. Housing starts were 1.53M compared to 1.60M expected. Unemployment claims registered 348,000, less than expectations of 362,000. The Philly Fed Manufacturing Index, although positive, came in at its lowest level of 2021, 19.4 vs. 23.2 expected.

With the markets not pushing through highs like they have been and the Russell 2000 briefly falling into correction territory, Bespoke Investment Group studied historical monthly drawdowns that compare nicely to current market conditions. August, September, and October have experienced the largest median drawdowns historically.

Not only have August, September, and October experienced the largest median drawdowns, but throughout history, these months have also had the highest number of drawdowns that exceed 5%.

Interestingly, the smaller the stock, the weaker the performance lately. Although the large-cap S&P 500 remains in an uptrend and above its 50-day moving average, the S&P small- and mid-cap ETFs are starting to breakdown from a technical perspective.

From 52-week highs, the average S&P 500 large-cap stock is down a little over 10%, while the average small-cap stock in the S&P 600 is down over 21%. The table below shows the average distance from 52-week highs for sectors across the different size indices tracked by the S&P. Just four large-cap sectors are down double-digits from 52-week highs, while seven small-cap sectors are down over 20%.

With markets in just their first month of an historically bad three-month period in terms of drawdown, employing dynamic risk management in the portfolio decision-making process could help preserve gains and limit losses. This is especially true if there is spillover from small-caps into the large-cap segment of the market or if volatility continues to intensify over the coming months.

Bonds

Throughout most of last week, yields moved lower on fears pertaining to the delta variant, dovish sentiment from Federal Reserve policymakers, and weak retail sales. The 10-year Treasury continues its breakout attempt from the bear price channel that started forming in May 2021. The upper limit of the channel is currently being tested for support, while a break below 1.20% would put the 10-year Treasury back in the middle of the bear channel. However, if support holds, trading action above 1.37% could signal a move higher.

T. Rowe Price traders reported, “Despite weakness in the macroeconomic backdrop, healthy levels of demand for corporate bonds in both short and long maturities were observed at these wider spread levels. New issuance came in under relatively low weekly expectations, but the deals that reached the market were well-subscribed. Investors favored higher-rated bonds within the high-yield universe, and BB rated bonds outperformed for the week.”

Gold

From a technician’s perspective, last week was a consolidation week for gold as highlighted in the yellow shading on the chart below. Consolidating right below its 50-day moving average last week, this week started off with a large upward gap piercing through the 50-day moving average with the next line of resistance at the 200-day moving average. Gold has struggled to find a consistent trend this year following a bullish 2020. As the yellow metal currently sits in the middle of its 2021 price range, it has some open space to go in either direction before a long-term trend in price can begin to take shape.

Investors continue to step in and bid up the metal selectively. This has been occurring mostly during pullbacks and consolidation periods. If gold can break through multiple levels of resistance above, it could produce enough momentum to get the metal out of its 2021 sideways range.

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

Our very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure was 200% long to start last week, changed to 160% long on Tuesday’s close, changed to 180% long on Wednesday’s close, changed to 190% long on Thursday’s close, and back to 180% long on Friday’s close to begin this week. Our QFC Political Seasonality Index continues to favor stocks with its buy signal on August 20. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.)

Our intermediate-term tactical strategies are positive, although to varying degrees. This makes sense considering the trend and volatility as markets are making new highs. The key advantage these strategies offer to investors is their ability to adapt to changing market environments, participate during uptrends (as they are currently), and adjust exposure to more defensive posturing during downtrends.

The Volatility Adjusted NASDAQ (VAN) strategy started last week 200% long to the NASDAQ and remained fully leverage to begin this week. The Systematic Advantage (SA) strategy is 90% exposed to the S&P 500, and our Classic model is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long throughout last week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Flexible Plan’s Growth and Inflation measure is one of our Market Regime Indicators. It shows that we remain in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and positive monthly GDP reading). Historically, a Normal environment has occurred 60% of the time since 2003 and has been a positive regime state for stocks, bonds, and gold. Gold tends to outpace both stocks and bonds on an annualized return basis in a Normal environment and carries a substantial risk of a downturn in this stage. From a risk-adjusted perspective, Normal is one of the best stages for stocks, with limited downside.

Our S&P volatility regime is registering a Low and Falling reading, which favors stocks over gold and then bonds from an annualized return standpoint. The combination has occurred 37% of the time since 2003.



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