Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

3rd Quarter | 2020

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 9/28/20

The major stock market indexes finished mixed last week. The Dow Jones Industrial Average lost 1.75%, the S&P 500 Index fell 0.6%, the NASDAQ Composite rose 1.11%, and the Russell 2000 small-capitalization index lost 4.0%. The 10-year Treasury bond yield fell 3 basis points, and bond prices were flat. Last week, spot gold closed at $1,861.58, down $89.28 per ounce, or 4.6%.

“Don’t fight the tape” and “Don’t fight the Fed” are not anti-pugilist mottoes but rather sound advice passed down over the generations for traders in the U.S. stock market. The former cautions against going against the market trend, while the latter warns investors to invest on the same side of the market as the Federal Reserve policymakers. If the Fed is encouraging loose money with low interest rates, investors can prosper in stocks and bonds. But if the Fed is tightening and rates are moving higher, it may be best to avoid both and retire to money market investments. Or so the story goes …

Today’s investors seemingly have the best of both worlds. With a new market high just weeks ago, we are still within the upward-sloping trend of the S&P 500 (shown in the chart above) that’s been with us since March 2009. And the Fed just completed a week where its open market purchases of bonds and other investments topped $44 billion. There is no doubt what Fed policy is. It is doing all of this with the intention of stimulating the economy to get the nation through the financial woes of the pandemic.

These twin engines of growth can certainly continue to power both stocks and bonds higher. Yet we just had our fourth week in a row where most of the stock market indexes have registered weekly losses. And those same indexes have plunged through their first line of defense—their 50-day moving average. Fortunately, the 200-day moving average has held as it often does, and stocks rallied strongly on Monday (9/28).

The rally was propelled principally by news stories that party leaders on both sides of the aisle were hinting at future talks about a new stimulus package. Such a package would provide support for the Fed’s policy, as various Fed governors have cited the need for fiscal stimulus from Congress to partner with their monetary stimulus to ensure that the American economy can continue to recover. But these are just rumors. We’ll see if the politicians can do anything before the election.

Earnings and the economy are not waiting around to find out. Both have been surging. In doing so, they have positively surprised earnings analysts and economists repeatedly over the last few months and created new multi-year high-water marks for the number of positive surprises that have occurred in both earnings and economic announcements. Earnings guidance has become so frothy that it set a new all-time record for the number of positive company earnings guidance announcements (positive less negative net total).

Noteworthy among last week’s economic announcements were the robust manufacturing reports and the soaring housing-production data. Both provided a strong justification for the stock market gains earlier in the summer.

The monthly retail sales report was absolutely stunning. As the following chart shows, sales have not only recovered from the pandemic decline in the spring, but they have roared higher still and set a new all-time record, beating the old mark by 1.5%!

This is perhaps a reflection of the news announced by the Federal Reserve last week that American households’ net worth surged in the second quarter to surpass its pre-pandemic peak. The 6.8% gain was the largest in quarterly data going back to 1952.

Still, there are many doubters. The Yale University Crash Confidence Index seeks to capture investor sentiment as to the likelihood of a market crash. With the pandemic still upon us, and a divisive election looming, it is little wonder that investor sentiment has been highly skeptical of the stock market. Yet, as a perusal of the following chart will disclose, whenever the Crash Confidence Index has been this high, the most likely result has been a market rally, not a crash.

Our Political Seasonality Index says that history tells us that stocks could still show more weakness until Wednesday, but then it switches to a new buy signal. (Our Political Seasonality Index is available post-login in our Solution Selector under the Domestic Tactical Equity category.) Also coming soon is our “Elections and the Financial Markets” series, which will add some historical perspective to the likely impact the upcoming election will have on markets.

Bonds

As part of its stimulus policy, the Federal Reserve has continued its largest purchases of bonds and ETFs in history, causing its balance sheet to grow about $1.5 trillion since March. Yet interest rates and bond prices have flatlined in September, as demonstrated by the chart of the TLY 20-year-plus government bond ETF.

This is certainly better than what has happened in the stock market (see above) or to gold (see below). Our popular Government Income Tactical and QFC Fixed Income Tactical strategies have held their own over this period.

Of course, the reason bonds have been flat is that interest rates are near zero. Despite the huge inflows of funds into bond mutual funds and ETFs this year, bonds do not compare well with stocks. One measure is a comparison of stock and bond yields. The S&P 500 dividend yield is now almost six times (5.75) greater than the yield on the 10-year government bond. In the past, this level of disparity has led to superior performance for stocks.

Gold

Gold continued its slide in price that commenced at the end of July. At first, the culprit was rising interest rates. Higher interest rates discourage gold investment because they increase the opportunity cost of storing dollars in gold instead of interest-bearing securities. This continued to be the case in August.

Then as September began and bonds and interest rates flattened (see Bonds section), a new offender appeared on the scene. This month, a strong U.S. dollar has soured investors on the yellow metal. As the chart above demonstrates, the latest downturn has coincided with a substantial improvement in the dollar, reversing a long-term downtrend in the greenback.

The indicators

The short-term trend indicators we monitor for stocks remain bearish. However, a number of price patterns have surfaced that suggest, with degrees of historical success that vary between 75% and 90%, price strength over the next five to 10 trading days. In addition, the NASDAQ is back to leading the S&P 500 Index in short-term performance, and that tends to be bullish for stocks in general.

The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure remains at 0.

Our intermediate-term tactical strategies are uniformly positive, although to various degrees. The Volatility Adjusted NASDAQ (VAN) strategy has an 80% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 62.5% exposed to equity funds, our Classic strategy is in a fully invested position, and our Self-adjusting Trend Following (STF) strategy remains 100% invested. VAN, SA, and STF 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 Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative monthly GDP reading).

Stagflation is the next-to-worst regime stage for stocks in terms of both return and drawdown. It is the best regime stage for gold on both measures. It is normally a period of middle-of-the-road returns for bonds with low volatility. Since 1972, the economy has been in a Stagflation stage only 9% of the time. So we have a limited history upon which to base a forecast.

Our Volatility composite (gold, bond, and stock market) is showing a High and Rising reading, which favors stock returns over gold and then bonds. This stage occurs about 23% of the time and is a stage of medium returns for all asset classes but with substantial volatility for all but bonds.

All of us here at Flexible Plan wish you and your families health and safety in these difficult times.

Jerry



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