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.

Market Update 9/13/21

By Jerry Wagner

The major U.S. stock market indexes were generally lower last week. The Dow Jones Industrial Average lost 2.1%, the S&P 500 Index fell 1.7%, the NASDAQ Composite gave up 1.6%, and the Russell 2000 small-capitalization index slumped 2.8%. The 10-year Treasury bond yield gained 2 basis points to finish at 1.28%, sending bond prices lower for the week. Spot gold closed the week at $1,788.35, down $39.37 per ounce, or 2.2%.

Stocks

New highs were registered by both the S&P 500 and NASDAQ 100 indexes just recently on September 2. But last week, talk of new highs was silenced by five straight days of losses.

As the chart of the S&P 500 above suggests, even after the week of losses, the market is still in overbought territory (just barely in the red). Stocks are also overpriced on a valuation basis, with high price-earnings ratios.

Economic indicators remain soft. SentimenTrader’s indicator of macroeconomic factors remains negative.

Employment numbers continue to confound. Just a week after an extremely bad employment report, last week’s weekly initial jobless claims report was just 310,000, substantially below estimates for a post-pandemic low. Confusing the issue further, with more than 10 million jobs openings across the nation, the number of jobs available topped the number of unemployed workers by over 2 million.

Perhaps the biggest economic news item of the week, and certainly the one that seemed to spook investors most of all, was Friday’s (September 10) announcement by the Bureau of Labor Statistics about its producer price index (PPI), which measures the average change over time in the selling prices received by domestic producers for their output. The PPI increased 8.3% over the last year. This was the largest annual advance since the bureau began publishing yearly figures in 2014.

Inflation is generally perceived as bad for the economy. It robs workers of their hard-earned wage gains and reduces the purchasing power of the salaries received. It pushes interest rates higher and bond prices lower. However, its impact on other investments varies.

Gold and other commodities usually see their prices rise in inflationary periods. While this is good for investors in such items, as well as farmers and miners, it is not so good for consumers who have to pay higher prices. Increases in the price of oil seem to have an immediate impact on gasoline prices at the pump but are good for energy company stock prices, just as higher interest rates tend to benefit financial companies such as banks.

So as we can see, rising inflation need not be considered a negative for the stock market. After all, investing in stocks is often touted as one of the best ways to outpace inflation.

In studying—and experiencing the effects of—the stock market over the last 50 years, it seems to me that inflation is most often good for stocks. But extreme changes in the PPI or the consumer price index (CPI) generally result in lower stock market prices. These changes can be in either direction. If these measures of inflation fall (as in deflationary, often recessionary times), or rise greatly in times of runaway inflation, stocks tend to slide in price.

I say they “tend” to fall because these measures are not precise market-timing indicators. For example, Friday’s PPI reading qualified as an extreme change. In the past, large rates of annual change in the PPI value would have generally led to falling stock prices.

In the 30 occasions since 1914, according to SentimenTrader’s Jay Kaeppel, when the annual rate of change in the value of the PPI was greater than 9% (the latest reading is 19.8%), the Dow Jones Industrial Average reacted as follows:

• 5 have shown a gain (average +8.2%).

• 15 have shown a loss (average -9.7%).

It’s not perfect, and so we require other confirming indicators before we would exit the market.

September has generally been the worst month for stock market investors. As a result, our Political Seasonal Index (PSI) is currently out of stocks. It exited on September 3, a day after the all-time high was registered in the S&P. But despite September’s dire reputation, the PSI indicates three buy signals and two sell signals during the remainder of the month. Not trading just because it’s September would miss these opportunities. (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.)

Another indicator with a long history of keeping investors on the right side of the market is known as the “equity risk premium.” This is the difference between the earnings yield (average earnings per share of the index stocks divided by their average price) of the S&P 500 and the interest rate yield of the 10-year Treasury bond. Currently, the difference is 2.4%.

Over the last 20 years, buying and holding the S&P whenever the difference was equal to or above this level has been profitable 89% of the time and yielded an average return over the next year of over 14%. A great record, but 11% of the time you lost money and the losses on those occasions reached double digits.

There is no perfect indicator. That’s why we create strategies that contain multiple indicators and then double down with our turnkey portfolios that employ multiple strategies. These prepackaged indicators, strategies, and portfolios do all the difficult work of sorting out what is working from what is not, and then employ those methodologies with the best chance of success. By design, the use of combinations of indicators and strategies increases the opportunities for profits and the mitigation of losses.

The rise of the delta variant has increased COVID cases and fears, which can translate into market uncertainty. This may manifest itself as further pressure on stock prices in September. Yet results in the largest study of the variant (more than 229,000 subjects in the U.K. since 2/1/2021) 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). We’ve observed a lower death rate in this country as well.

The “herd immunity” data we discussed here continues to show that 18 countries (including the U.S.) are at the RO 3 level of herd immunity (10, again including the U.S., are at the RO 4 level). In addition, 44 of the 50 states have achieved herd immunity at the first level (19 at the RO 4 level).

This suggests that the economic impact of the virus, delta variant or not, is likely to be much lower than many have forecast. This is another possible positive for investors.

Bonds

While both 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 the July gains have been substantial, it’s obvious from the charts that the government bonds have succumbed to the inflation fears discussed above and topped out while the high-yield bonds continue to track stocks to new highs.

As long as the intermediate-term trend in stocks remains intact, this is likely to continue to be the case for high-yield bonds. And if this week’s CPI report is as bad as the PPI report last week, government bonds are likely to feel increased downward pressure. However, expectations are that the cooling in CPI growth that suddenly appeared last month will spill over into the report this week. If so, bonds will benefit.

At Friday’s auction, the government failed to sell all of the 30-year bonds it had planned to unload to meet this country’s ever-growing deficits. In such circumstances, the usual way these bonds get sold is to raise interest rates further.

Gold

In contrast to stocks, where the intermediate uptrend has been preserved so far, gold has trended lower for most of the year. The March-May rally fizzled out in June, and now gold prices are stalled in a narrow, multi-month price range. They continue to be buffeted by inflationary pressures tending to move gold higher, while higher interest rates and gains by the U.S. dollar have generally exerted downward pressure on the yellow metal.

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. As pointed out above, our Political Seasonality Index has been out of the market since September 3, but it will venture back into stocks three more times in September. (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, after being out of stocks, has used the five-day decline to rebuild its position, reaching a 2X reading (200% long price movements of the S&P 500 Index) on Friday (September 10).

FPI’s intermediate-term tactical strategies are uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy has a 200% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 90% 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 Low and Falling reading, with stock returns historically outpacing gold and then bonds. This stage occurs about 37% of the time and is the best regime stage for stocks, both on an absolute and risk-adjusted basis.



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