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 9/6/22

By Tim Hanna

The major U.S. stock market indexes were down last week. The S&P 500 decreased by 3.29%, the Dow Jones Industrial Average lost 2.99%, the NASDAQ Composite was down 4.21%, and the Russell 2000 small-capitalization index fell 4.47%. The 10-year Treasury bond yield rose 15 basis points to 3.19%, taking Treasury bonds lower for the week. Spot gold closed the week at $1,712.19, down 1.49%.

Stocks

Equity markets finished the week lower as investors continued to digest hawkish messages from Federal Reserve officials. The market also reacted to Gazprom’s shutdown of its Nord Stream 1 natural-gas pipeline, citing a “technical issue” involving an oil leak. The Russian state-owned energy giant hasn’t indicated when the pipeline might reopen. The Nord Stream 1 pipeline news came shortly after G-7 members agreed to implement a price cap on Russian oil exports.

On the economic data front, The Conference Board’s Consumer Confidence Index came in at 103.2, better than the 97.6 forecast. ISM Manufacturing PMI registered at 52.8, slightly better than the 52.1 expected. Unemployment claims were at 232,000, lower than the 250,000 forecast. Average hourly earnings came in at 0.3% month over month, lower than the 0.4% forecast. The unemployment rate was 3.7%, higher than the 3.5% expected. Nonfarm employment change came in at 315,000, higher than the estimate of 295,000.

The S&P 500 Index is testing its lower support trend line (the black positive-sloping line on the chart below). The Index had been rising off lows set in June, but then stumbled at the upper resistance line of this year’s bear channel (see the following chart). The upper trend line (the black negative-sloping line on the following chart) coincides with the Index’s current 200-day moving average, a measure widely used by technicians to identify long-term trends and levels of support and resistance. This is the first major leg down following yearly lows set in mid-June. Currently, the Index is below its 50-day moving average and on its way to test levels not seen since July if support does not hold at these levels.

With the S&P 500 Index seeing textbook resistance at its 200-day moving average in mid-August, the streak of closes below the 200-day moving average extended into triple digits. Bespoke Investment Group found that streaks of 100-plus trading days below the 200-day moving average are not uncommon, with some streaks lasting much longer as shown in the following chart.

The current streak is the longest since the 2008 financial crisis. The financial crisis streak lasted 358 trading days, the longest streak since post-WWII. The following table shows the performance of the S&P 500 after the 100th day of each prior streak and the one-year performance once the streak ended. Average and median returns following 100 days of closes below the 200-day moving average have been negative over one-, three-, and six-month periods, with gains less than half of the time. One year later, average and median returns were positive but well below the post-WWII historical average for one-year periods. It wasn’t until the streaks came to an end that the S&P 500 started to post better-than-average returns.

An unusual aspect of this year’s stock sell-off is the lack of protection that bonds have provided as rates continue to rise. The traditional 60/40 portfolio of stocks and bonds is on pace for a historically bad year. Using the S&P 500 as a stock proxy and the Barclays Aggregate Bond Index as a bond proxy, the traditional portfolio is down 14% year to date on a total return basis. This is easily the worst year-to-date performance through August since at least 1976.

Often used by passive investors, the 60/40 portfolio is intended to provide protection via bonds, as they tend to gain value when stocks decline. This is due to the historical negative correlation between the two asset classes. But this approach has not served investors well this year as bonds have mostly followed stocks down.

Whether the market goes on to set new yearly lows or breaks its streak by finding support, it’s more important than ever to invest in dynamically risk-managed strategies that are able to respond to changing market conditions. With the uncertainty of the future relationship of stocks and bonds during downturns, it is especially wise for passive investors that employ a static stock-bond split to consider investing in dynamically risk-managed strategies.

If volatility persists and prices continue to fall, systematic momentum strategies are designed to identify the change and stay in or move to defensive positioning. If prices reverse direction and volatility is low, systematic trend-following algorithms are designed to recognize the price momentum and participate in a risk-on fashion.

The following chart shows the year-to-date performance of the Quantified Managed Income Fund (QBDSX, -2.0%) compared to the iShares Core US Aggregate Bond ETF (AGG, -12.3%). The Quantified Managed Income Fund is an actively managed income fund that can seek various income classes as well as the safety of cash when market exposure is undesirable. The Fund is a key defensive component in several actively managed strategies at Flexible Plan Investments.

Bonds

The yield on the 10-year Treasury rose 15 basis points, ending last week at 3.19% as the bond market continues to battle with a long-term trend of rising interest rates. The 10-year Treasury yield is now within 30 basis points of its high set in mid-June.

Trading activity below its 50-day moving average failed to provide any substantial and prolonged decrease in yields. The pullback was again a short-term “bull flag” (the black lines on the following chart), which looks to be trying to break out above this year’s high (which would be negative for bond prices). Such patterns are considered continuation patterns, with breakouts targeting new highs and a continuation of the longer-term trend.

The major catalyst for the rise last week was the Federal Reserve’s continued focus on fighting inflation with rising interest rates. Investors fear the ramifications of such an unprecedented rate-hike cycle. Data suggesting continued tightness in the labor market also helped push Treasury yields higher. Last week, the two-year Treasury yield traded north of 3.5%, levels not seen since late 2007.

T. Rowe Price traders reported, “Investment-grade corporate bonds suffered from the weaker macro backdrop. Secondary trading volumes were below daily averages, and no new issuance occurred. The sell-off in Treasuries pressured high yield bonds and bank loans as the market continued to assess the Fed’s hiking trajectory and its impact on growth. As expected, no new high yield bond issues were announced this week, but several financing deals are anticipated after Labor Day.”

Gold

Last week, gold lost 1.49%, setting a new 52-week low. The yellow metal failed to continue its move upward that started in the second half of July. It found resistance at its 50-day moving average in early August and has experienced a substantial leg down since then. The early July sell-off resulted in a death cross (when the 50-day moving average crosses below the 200-day moving average). With this leg down, the gap between the 50-day and 200-day moving averages has widened.

Since mid-July, the U.S. dollar’s weakness has provided some relief for gold (the purple line in the following chart). A higher dollar is a restraint on global liquidity and a headwind for inflation in the U.S. In general, a stronger dollar lowers the price of imports. The U.S. dollar and other non-equity or bond exposures are available asset classes for consideration within certain strategies at Flexible Plan Investments.

The story continues. As gold has struggled since late April, the U.S. dollar has marched higher. Pullbacks in the U.S. dollar have resulted in retracements for the yellow metal, but the bear-channel price structure remains for gold.

While the fundamental case for gold in 2022 was strong as geopolitical tensions, recession fears, and the impact of Fed rate hikes held center stage, the technicals have not resembled that negative backdrop. With only four months left in the year, gold may see some upward movement due to mean reversion in the short term, especially if we see sustained weakening in the U.S. dollar.

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

The very short-term-oriented QFC S&P Pattern Recognition strategy started the week with 0% exposure. Exposure changed to 60% long at Monday’s close, 130% long at Tuesday’s close, 180% long at Wednesday’s close, 90% long at Thursday’s close, and 30% long at Friday’s close. Our QFC Political Seasonality Index favored stocks throughout last week. (Our QFC Political Seasonality Index is available—with all of the daily signals—post-login in our Weekly Performance Report section under the Quantified Fund Credit category.)

Our intermediate-term tactical strategies have been varied in their degree of defensive positioning. The key advantages these strategies offer to investors are their ability to adapt to changing market environments, participate during uptrends, and adjust exposure to more defensive posturing during downtrends.

The Volatility Adjusted NASDAQ (VAN) strategy was 40% short the NASDAQ to start the week. Exposure changed to 20% short at Monday’s close where it remained until the end of the week. The Systematic Advantage (SA) strategy is 30% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy started the week 100% exposed. It changed to 0% exposure at Monday’s close, remaining flat throughout last week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic model remained in stocks last week. Most of our Classic accounts follow a signal that will allow the strategy to change exposure in as little as a week. A few accounts are on platforms that are more restrictive and can take up to one month to generate a new signal.

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

Our S&P volatility regime is registering a High and Falling reading, which favors gold over bonds and then stocks from an annualized return standpoint. The combination has occurred 13% of the time since 2003. It is a stage of higher returns and lower volatility for bonds relative to the other volatility regimes.



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