Market insights and analysis

By Jason Teed

The major U.S. equity indexes were mixed last week. The NASDAQ Composite, the only winner for the week, gained 0.55%. The Dow Jones Industrial Average fell 2.70%, the S&P 500 lost 0.66%, and the Russell 2000 dropped 1.04%. The spreads between index performance seemed to widen over the week, both on days when the indexes fell and as they recovered.

Three of the 11 sectors were up for the week. Communication Services gained the most, up 2.97%. Utilities and Industrials lost the most, down 2.93% and 3.36%, respectively. There seemed to be no trend among cyclical and defensive sectors for the week, making sector-specific economic pressures the likely driver of sector movements.

Stocks

Positive and negative factors are affecting equity movements.

On the positive side, it appears that global indexes, particularly international indexes, are recovering.

Both Europe and China underperformed the U.S. for the majority of 2022. China was hit particularly hard by COVID lockdowns and then by an increase in COVID cases after the country pulled back on its “zero-COVID” policy. But both regions are recovering in 2023. Year to date, Europe is up over 7% and China is up over 13%, while the S&P 500 is only up about 3.5%.

Additionally, some economists are projecting that the eurozone will not have a recession in 2023, despite pressures from higher interest rates and increased geopolitical conflict. Emerging markets have also been buoyed recently after languishing behind developed markets for multiple years.

Also, the U.S. dollar has been weakening steadily for the last few months. This allows domestic companies to sell their products internationally at a lower price from the perspective of international buyers.

Typically, when the U.S. dollar has a prolonged period of decline, earnings of U.S. companies tend to rise. Data from 1980 to 2022 shows that after significant dollar declines, U.S. equities have either stayed flat or risen (see the following chart).

Of course, things may be different this time. We currently face different headwinds than any of the periods represented in the following chart; however, it will remain a support for the U.S. market in the coming months.

On the negative side, several economic indicators are beginning to flash red, and it doesn’t appear that the stock market is pricing in any potential bad news.

Morgan Stanley recently suggested that while the upcoming recession may be milder than expected, it appears that the U.S. stock market has not yet priced in the declining forward earnings projections from U.S. companies. The current earnings season is not expected to be a positive one, and the market has been in a bullish mode since October.

Retail sales in December were lackluster, with declines of 1.15% from November. November itself was revised down to a decline of 1% from estimates of 0.6%. Only three retail sectors showed gains from the previous month, making what is typically a robust shopping period for the year disappointing.

Furthermore, several leading economic indicators are also suggesting a slowdown. For example, current and projected shipments and new orders are down compared to historical levels. Prices paid and employment, though lagging somewhat, are still enjoying relatively strong levels.

Demand seems to be the issue with these reports, suggesting that the Federal Reserve’s increased rates are having a significant impact. It will take some time, however, for these numbers to work their way through the business cycle, resulting in depressed earnings and likely a weaker job market.

With such weakness apparently on the way, it has been surprising how robust the U.S. equity markets have been over the past few months.

Forward earnings per share for U.S. companies have been declining since mid-2022. The markets seemed to have priced in higher interest rates but not declining earnings. On top of this, corporate earnings are expected to continue to decline into 2023. Morgan Stanley has suggested that such repricing may occur in the first quarter, allowing stocks to recover in the latter portion of 2023 and into 2024. Other firms such as JPMorgan and Bank of America have also signaled significant concerns over earnings, suggesting that the recent market run-up is not justified.

We may be destined for more of the whipsaw events that we saw for the majority of 2022. The U.S. equity markets will likely decline further despite recent economic action once market participants begin pricing in declining corporate earnings.

Bonds

Treasury yields were mixed for the week. Yields for periods shorter than one year rose. Longer-term yields fell—except for the 30-year yield, which also rose. Three-year yields fell the most, suggesting the market anticipates rising rates in the short term but more responsive Fed action as the economy slows down.

Last week’s market movements further inverted the yield curve, and credit spreads widened by nearly 50 basis points. Both of these suggest further market pain is possible. Overall, long-term Treasurys outperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

Gold

Spot gold rose 0.30% for the week. The metal has risen nearly 16% since its bottom near the end of September last year.

In 2022, the metal faced significant headwinds as the Fed attempted to get inflation under control by increasing interest rates. This upward pressure on the U.S. dollar’s value suppressed gold’s value. Now that these conditions are changing, gold has enjoyed tailwinds that are likely to continue for the next few months.

Non-currency safe-haven assets, such as long-term Treasurys, were down for the week, as longer-term rates rose for the period. Higher-than-average correlation among bonds, equities, and gold this year due to rising rates has made investing across the spectrum more difficult for investors, though these conditions also appear to be changing as we move further into 2023.

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 but entered on Tuesday’s (1/17) close. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure began the week 0.9X short. It changed to 0.7X long on Wednesday’s close, 1.4X long on Thursday’s close, and 1.2X long on Friday’s close. The strategy has been much more active lately than in the earlier parts of 2022.

Our intermediate-term tactical strategies are mixed in exposure. The Volatility Adjusted NASDAQ (VAN) strategy was neutral for the week. The Systematic Advantage (SA) strategy began the week 120% exposed to the market. It changed to 60% exposed on Tuesday’s close and to 30% exposed on Thursday’s close, where it remained for the rest of the week. Our QFC Self-adjusting Trend Following (QSTF) strategy began the week 1X long, changed to neutral on Thursday’s close, and remained there for the rest of the 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 for the week. The strategy can trade as frequently as weekly.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, currently indicates a Normal economic environment stage (meaning a positive monthly change in the inflation rate and positive quarterly GDP reading). Historically, a Normal environment has occurred 60% of the time since 2003 and has been a positive regime state for equities, gold, and bonds. Gold tends to outpace both stocks and bonds on an annualized return basis in a Normal environment, albeit with higher risk.

Our S&P volatility regime is registering a High and Falling reading, which favors gold over bonds and then equities from an annualized return standpoint. The combination has occurred 13% of the time since 2000. It is a stage of relatively high returns and lower volatility for the three major asset classes.