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 Jason Teed

The major U.S. stock market indexes fell significantly last week, ending the market rally that begin in mid-June. The Russell 2000 was the strongest performer with a 2.94% loss. The NASDAQ Composite was the weakest performer, falling 4.44%. The S&P fell 4.04%. The 10-year Treasury bond yield rose 7 basis points to 3.04%, continuing a run-up that began on August 1. Spot gold closed the week at $1,738.14, down 0.51%.

Energy was the only sector out of 11 to make gains. The sector was up 4.27% last week on higher oil prices, which continue to rise due to ongoing geopolitical concerns. Risk-on sectors tended to fall the most for the week. Technology was the worst-performing sector, falling 5.58%.

Stocks

The stock market experienced its largest weekly losses since June last week, mostly due to comments from the Federal Reserve.

The Fed suggested that it will “use [its] tools forcefully” to get inflation back into the range of 2%, acknowledging that economic pain will be part of the process.

The equity market is used to the Fed’s support, so much so that it has coined an industry term for it: the Fed put. Investopedia defines the Fed put as “the market belief that the Fed would step in and implement policies to limit the stock market's decline beyond a certain threshold.” It appears that the Fed wants it known that this put is no longer in place.

The markets were not prepared for this level of Fed hawkishness, as recent reports suggest that inflation is beginning to soften.

The Fed, however, expects that aggressively tackling rates will still be necessary as inflation remains in the high single digits. Comments from an exiting Fed president suggested rates may remain above 4% for a prolonged period, but forward rates on short-term interest rates have been predicting rates consistently below this level.

On top of this, equity markets have not significantly reacted as two-year rates have increased from recent lows at the beginning of July. Typically, when interest rates have risen this year, stocks have fallen. This is because corporate earnings come under pressure when interest rates rise, as the cost of borrowing increases.

Not only is the market underestimating what interest rates will be doing going forward, but it’s also not responding to current increasing rates. This makes the market ripe for a correction, which we’ve seen play out over the past few days. How long and how deep this correction will be is unknown.

Additionally, the yield curve is experiencing its deepest inversion since the early 2000s. Yield-curve inversions are often predictive of market recessions, and a recession seems even more likely going forward considering the depth of the inversion.

It’s unlikely that we’ll see an inversion as deep as those in the late 1970s and early 1980s, but it will likely be one of the steepest in recent memory. Most economists agree that a recession is likely at this point, but when it will occur has been in dispute. Some economists suggest we are already in a recession of indeterminate length, while others believe the recession may not begin in earnest until mid-2023.

The news isn’t all bad. Among the major developed global economies, the U.S. remains the strongest. The most recent estimate of Q2 GDP was revised up 35 basis points, though it was still negative. Goods orders and jobs reports have been stronger than expected. Initial and continuing jobless claims were better than estimated and lower than more recent highs. This suggests the jobs market isn’t responding dramatically to rising rates, and that rumors of hiring freezes and layoffs may be limited to specific sectors or industries.

Overall, further volatility and downside are expected in the equity markets as the Fed continues to fight inflation. The Fed has made it clear that it will not rescue equity markets at the expense of high inflation, suggesting now is a good time for an actively managed investment portfolio.

It’s unlikely that the next recession will be as deep as the one experienced during the financial crisis, but the exact depth and length remain unknown. It seems more likely that going forward the markets will take these risks more seriously.

Bonds

Treasury yields were up for the week. Shorter-term yields rose faster than those at longer maturities.

The two-year/10-year yield curve is deeply inverted. The term yield fell 9.8 basis points, and credit spreads rose about 15 basis points. These both suggest an impending economic slowdown. Overall, long-term Treasurys outperformed high-yield bonds, and longer-term bonds outperformed shorter-term bonds.

The market expects rates will continue to rise, with potentially further aggressive rate hikes this year, as the Fed continues to combat high inflation. Economic messaging from the bond market appears to be pessimistic this week.

Gold

Spot gold was down, remaining near lows for the year. Year to date, the metal is down about 4.8% after experiencing significant volatility.

Gold has suffered headwinds since early March. The U.S. dollar has continued to rise to its strongest levels in nearly two decades. Gold and the U.S. dollar tend to have an inverse relationship.

As inflation appeared to soften, the metal saw an increase in value from mid-July to mid-August, though it has been trending downward since that time.

Non-currency safe-haven assets, such as long-term Treasurys, were up for the week, with safe-haven status overpowering concerns of rising rates on the short end of the curve. This suggests that the market was in a risk-off mode, and investors were largely seeking safety amid expected forward volatility. This year we’ve seen a high correlation between bonds and stocks, making such an observation in long-term Treasurys all the more exceptional.

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

Our Political Seasonality Index began last week fully invested, selling out of the market on Wednesday’s close. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure began last week 0.1X short. It changed to 0.6X long on Monday’s close, 1.3X long on Tuesday’s close, and 0.6X long on Thursday’s close. It sold out of the market on Friday’s close to begin this week.

Our intermediate-term tactical strategies have mixed exposure. The Volatility Adjusted NASDAQ (VAN) began last week with a 20% inverse exposure to the markets, changed to 40% inverse on Tuesday’s close, and changed back to 20% inverse on Thursday’s close. The Systematic Advantage (SA) strategy began last week 60% exposed to the market, changed to 30% exposed on Tuesday, changed to 90% exposed on Wednesday’s close, and remained there to begin this week. Our QFC Self-adjusting Trend Following (QSTF) strategy was 1X exposed to the market last week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic strategy was fully invested last week. The strategy can trade as frequently as weekly.

Many of our strategies remain relatively underexposed to the market, having exited several weeks ago. Some have reentered since mid-June in an effort to take advantage of short-term trading opportunities. Volatility remains high and overall market direction has been down year to date. Market professionals expect additional downside volatility.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, shows that we remain in the Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative quarterly GDP reading). The environment has occurred only 9% of the time since 2003 and has been a positive regime state for gold and bonds, while equities tend to fall. Gold tends to significantly outpace 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 one of the best stages for gold.

Our S&P volatility regime is registering a High and Rising reading, which favors equities over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2000. It is a stage of lower returns and higher volatility for all three major asset classes.



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