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.

Market Update 9/19/22

By Jason Teed

The major U.S. stock market indexes fell significantly last week, continuing a trend downward that began in mid-August. The Dow Jones Industrial Average lost 4.13%, the S&P fell 4.77%, and the NASDAQ Composite declined 5.48%. The 10-year Treasury bond yield rose 14 basis points to 3.45%, continuing a run-up that began on August 1. Spot gold closed the week at $1,675.06, down 2.43%.

All 11 sectors were down for the week. Health Care fell the least, losing 2.38%. Risk-on sectors tended to fall the most for the week. The Materials sector was down 6.65%. Energy was an outlier for cyclical sectors, falling only 2.60% for the week.

Stocks

Economic news offered little optimism last week, resulting in the largest weekly losses since June.

The markets were hit with two significant negative news items: (1) higher-than-expected inflation readings and (2) weaker-than-expected earnings data and abysmal forward guidance from FedEx.

Inflation for August came in with a core reading of 6.3% and a month-over-month reading of 0.6%, less than the expected 6.1% and 0.3%, respectively. Core inflation strips out more volatile components of the consumer price index (CPI), such as energy and food.

After several 75-basis-point increases in the fed funds rate, expectations were that the Federal Reserve would be able to slow down, therefore reducing the chances of causing a recession. But with inflation readings remaining high, the Fed will likely have to persist with aggressive interest-rate hikes.

In fact, investors are currently pricing in a 20% probability that the Fed will increase the fed funds rate by a full 100 basis points at its meeting this week—though an additional 75-basis-point increase is more likely.

While parts of the economy appear strong (jobs, for example), some companies are predicting slowdowns and softening earnings. FedEx, a bellwether for economic activity, warned on Thursday (September 15) that “a slowing economy will cause it to fall $500 million short of its revenue target,” reports CNN. The shortfall was largely due to reduced demand in the later portion of the quarter. FedEx also suggested a drop of 40% in earnings in the coming quarter as global conditions continue to deteriorate. This report resulted in a 21% drop in the company’s stock that day, its largest single-day drop ever.

A slowing global economy was expected as central banks continue to raise rates in an effort to reduce worldwide inflation. Yet the magnitude of FedEx’s difficulties was unexpected, causing the market as a whole to plummet.

But it wasn’t all bad news last week. While FedEx is predicting a global recession, UPS is not lowering its guidance for the remainder of the year. And the producer price index (PPI), which reflects the price that domestic producers receive for their output, is showing signs of slowing. August’s reading was down 0.1% month over month, in line with expectations.

The following chart shows the normalized changes in various measurements of inflation over time. CPI measurements are peaking, but PPI readings are coming in at the lower end of their normalized range. Typically, the PPI tends to precede changes in the CPI, as it is further upstream in the supply chain. These lower readings in the PPI may soon make their way down to the CPI.

Overall, market sentiment and fundamentals appear to be down. But the Fed could still stick the landing with both inflation and the economy as a whole.

This market environment has been difficult for investors, particularly passive investors who rely on diversification with bonds to protect their portfolios. Bond prices and interest rates are inversely correlated. With interest rates rising, bonds have not offered the portfolio protection that is typical when stocks fall. The result has been the worst performance of the 60/40 portfolio in the last half-century.

The 60/40 portfolio represents the “average” investor and a balanced portfolio, highlighting how unusual this period has been. While equity markets have historically suffered losses greater than we’re currently experiencing, balanced portfolios have not fallen nearly so much—even during the depths of the financial crisis.

Ultimately, the Fed has anticipated and is even using this pain to try to slow inflation. Investors who feel less wealthy tend to spend less money. As long as inflation remains high, the Fed will continue on the same course, and passive investing will remain a difficult prospect. Dynamically risk-managed strategies can offer diversification and capital preservation even when few assets are rising in value.

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 yield curve has not been this inverted since the early 2000s. The term yield fell 17 basis points, and credit spreads fell about 11 basis points. In terms of future economic performance, the former suggests a slowdown but the credit spread suggests current strength. Overall, long-term Treasurys outperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

The market expects that 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 extremely pessimistic this week.

Gold

Spot gold was down, hitting new lows for the year. Year to date, the metal is down about 8.7% 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. With interest rates expected to rise, a strengthening dollar will continue to be a challenge for the metal in the intermediate term.

Like virtually all asset classes last week, non-currency safe-haven assets, such as long-term Treasurys, were down due to rising rates. The higher correlation among bonds, equities, and gold this year due to rising rates has made investing across the spectrum more difficult for investors.

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 out of the market. It bought into the market on Wednesday’s close and sold back out on Friday’s close to begin this week. (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 0.6X short. It changed to 1X short on Monday’s close, 0.4X short on Tuesday’s close, 0.7X short on Wednesday’s close, neutral on Thursday’s close, and 0.7X short on Friday’s close to begin this week. The strategy was very active on a relative basis; it doesn’t often trade each day of the week.

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

Our Classic strategy was out of the market for the week. The strategy can trade as frequently as weekly.

Many of our strategies remain relatively underexposed to the market, as the markets continue to move downward. 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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