Market insights and analysis

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

4th Quarter | 2023

Quarterly recap

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Current market environment performance of dynamic, risk-managed investment solutions.

By Tim Hanna

Market snapshot

•  Stocks: The major U.S. stock market indexes were down last week. Equity markets pulled back from 52-week highs set in December. With little selling pressure seen since the start of October’s rally, technicians expected a pullback due to overbought conditions. Data suggests that inflation has returned to the Fed’s target, and labor markets are showing signs of weakening.

•  Bonds: Treasury yields rose, with the 10-year Treasury yield testing the 4% level as the first level of resistance. The 50-day moving average is currently at 4.26%.

•  Gold: Gold fell 0.85% last week, experiencing its third pullback since the start of October’s rally.

•  Market indicators and outlook: Market regime indicators show the market is in a Normal economic environment stage, which is historically positive for stocks, bonds, and gold but with a substantial risk of a downturn for gold. Normal is one of the best stages for stocks, with limited downside. Volatility is Low and Rising, which favors gold over stocks and then bonds.

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The major U.S. stock market indexes were down last week. The Russell 2000 small-capitalization index fell 3.75%, the NASDAQ Composite was down 3.25%, the S&P 500 decreased by 1.52%, and the Dow Jones Industrial Average lost 0.59%. The 10-year Treasury bond yield rose 17 basis points to 4.05%, taking Treasury bonds lower for the week. Spot gold closed the week at $2,045.45, down 0.85%.

For the latest information on our Quantified Funds, check out our weekly fund updates. You can also see the daily holdings of the funds here.

Stocks

The S&P 500 Index is pulling back from 52-week highs set at the end of last year. The Index is trading well above its 200-day and 50-day moving averages. Since the October low, the market has experienced very little selling pressure, with the most coming last week during this upward leg.

Last week’s loss follows nine straight weeks of gains. Some of the sell-off may be attributed to investor profit taking and stocks pulling back from overbought conditions. The recent move up broke all-time highs set in January 2022, with the current pullback on track for a retest of the breakout level.

Bespoke Investment Group conducted a study comparing U.S. equity market factors now versus 2023, focusing on factors across eight major categories. In 2023, stocks exhibiting the least volatility significantly underperformed higher-volatility stocks, lagging by over 24%. In the current year, the trend has reversed: Low-volatility stocks are up 4.0% relative to high-volatility stocks. The growth factor presents a contrasting picture. Last year, growth stocks outperformed by 13.7%, when comparing the top to the bottom quintile. This year, growth stocks in the top quintile are down 1.9% compared to those in the bottom quintile.

Data suggests that inflation has returned to the Federal Reserve’s 2% target. Over the past six months, the core personal consumption expenditures (PCE) price index has seen an annualized increase of just 1.9%. When rent is excluded, the core inflation rate is significantly lower, registering an annual increase of less than 1% during the same period.

It’s been a long time since the start of the rate-hike cycle, but the labor market finally appears to be weakening. The Job Opening and Labor Turnover Survey (JOLTS) for November and the Employment Situation Summary for December have both indicated slowdowns in the labor market. While neither points directly to a recession, a shift in momentum is evident.

The most concerning indicator in the JOLTS data is the trend in hiring. The gross number of hires by employers fell 6% month over month, reaching its lowest level since September 2017, excluding the COVID-related downturn in 2020. This decline marks the lowest hiring rate since September 2014, again excluding the COVID period, and both figures suggest contracting demand. Additionally, the quit rate has steadily fallen from its April 2022 peak of 3.0% on a total nonfarm basis to 2.2% today. This is similar to the 2017 average rather than the post-COVID labor market. Lastly, openings continue to fall and have missed economists’ estimates.

Turning to the Employment Situation Summary, the household survey showed a drop of nearly 700,000 jobs in December. Although part of this drop might be attributed to seasonal factors, its magnitude is noteworthy. Further, there has been a large uptick in the number of unemployed workers. As a result, the proportion of “slack” workers in the total workforce has risen, currently standing at 9.3%. The figure was 8.7% in April 2023 and 8.8% at the peak of the last labor market. Wage growth also showed signs of weakening. Through December, the non-managerial wage growth (three months over three months and month over month) was 4.3% annualized, slower than the peak rate from the last cycle, when Fed cuts began six months later. Bespoke Investment Group interprets this labor data not as a cause for alarm, but as indicative of a broader slowdown that will lead the Fed to implement easing measures before midyear.

Although labor markets are slowing, GDP is projected to grow at an annualized rate of 2.5% in Q4, according to the Atlanta Fed’s GDPNow tracker, which monitors real-time growth data. The following table shows that this rate is among the highest readings of the quarter, suggesting that slow inflation and weak growth don’t always go hand in hand.

The new year is also bringing with it a broad rally in the U.S. dollar, which has risen against all but four currencies to start 2024. When adjusting for inflation differences across countries, the U.S. dollar stands out as particularly strong historically, despite experiencing a sell-off in late 2023. Some Flexible Plan Investment (FPI) investment strategies and funds make use of exposure to the U.S. dollar. The most frequent use occurs in the Quantified Evolution Plus Fund (QEVOX), which allocates among broad asset classes. Currently, the Fund has an overweight position in the U.S. dollar.

Although the market has experienced a short-term downward trend, the longer-term upward trend that began in October has not reversed, nor has it shown signs of reversing. It is important to incorporate dynamically risk-managed investment strategies that can adapt to changing market conditions as the changes are reflected in asset prices. This is especially important if the momentum that began in October loses steam and prices begin experiencing more significant selling pressure that is more synonymous with a “correction” rather than a “pullback.” Technicians are closely monitoring the current price levels, particularly to see if a retest of the market highs fails and leads to an inflection point.

For example, when markets exhibit positive momentum, many of our momentum-based strategies adjust their positioning to be more risk-on. If prices continue to rise, systematic trend-following algorithms are designed to identify and participate in the upward price momentum. Conversely, if volatility arises and prices decline, systematic momentum strategies are designed to identify the change and move to more defensive positioning. Mean-reversion strategies attempt to recognize and navigate sideways market conditions, offering an uncorrelated complement to momentum-based programs, which face challenges during trend-reversal inflection points.

Bonds

The yield on the 10-year Treasury rose 17 basis points last week, ending at 4.05%.

The 10-year Treasury peaked on October 19, pulled back significantly, and then experienced a post-Christmas retracement. The next level of resistance could be seen at its 50-day moving average. At present, the 10-year continues to test the 4.00% level. Technicians keep a close eye on the significant percentage levels (e.g., 3%, 4%, 5%, and so on).

T. Rowe Price traders reported, “U.S. investment-grade corporate bonds generated negative performance over much of the week. The start of the year brought heavy issuance, although less came to market than was widely anticipated. The majority of issuance was also shorter in duration, or less sensitive to changes in interest rates. …

“High yield bonds were also weaker as they retraced some of the positive performance during the last two weeks of December. Our traders noted that robust primary market activity is expected through January, with some estimates calling for issuance totals as high as $25 billion.”

Gold

Gold fell 0.85% last week, pulling back from the 52-week high set in late December. Gold is encountering its third pullback in the ongoing rally that began in October. The “golden cross” (when the 50-day moving average crosses above the 200-day moving average), seen by technicians as a longer-term trend signal to the upside, is still in play. Currently, price is trending to test the 50-day moving average (the dashed blue line on the following chart), which is not far away.

Nothing suggests that this sell-off isn’t a standard pullback within a longer-term uptrending bull-price channel. The recent low from December is still intact. One of the first signs to watch out for is the failure to make a higher high in this channel once prices trade upward again. If a new high is established that is lower than the one on December 27, technicians may interpret this as a potential indication of a trend change in the near term.

Flexible Plan Investments is the subadviser to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction 10 years ago to track the daily price changes in the precious metal in a more tax-efficient manner than its ETF counterpart, GLD.

The indicators

The very short-term-oriented QFC S&P Pattern Recognition strategy started last week with 120% short exposure. Exposure changed to 30% long at Monday’s close, moved to 120% long at Wednesday’s close, changed to 190% long at Thursday’s close, and changed to 130% 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 Domestic Tactical Equity 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 started the week with 140% long exposure to the NASDAQ, changed to 120% long exposure at Wednesday’s close, and moved to 140% long at Friday’s close. The Systematic Advantage (SA) strategy is 30% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long 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 throughout 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 is one of our Market Regime Indicators. It shows that we are in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and a positive monthly GDP reading). Historically, a Normal environment has occurred 60% of the time since 2003 and has been a positive regime state for stocks, bonds, and gold. Gold tends to outpace both stocks and bonds on an annualized return basis in a Normal environment but carries a substantial risk of a downturn in this stage. From a risk-adjusted perspective, Normal is one of the best stages for stocks, with limited downside.

Our S&P volatility regime is registering a Low and Rising reading, which favors gold over stocks and then bonds from an annualized return standpoint. The combination has occurred 27% of the time since 2003.



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