Market insights and analysis

By Tim Hanna

Market snapshot 

•  The major U.S. stock market indexes were down last week. Equity markets continue their downward bear-channel price structure following highs set in July. 

•  Treasury yields rose significantly, with the 10-year Treasury trading above 5.0% for the first time since 2007. 

•  The S&P 500 components are down 9.9% since the July 31 peak. Energy is the only sector to generate a gain since then. 

•  Gold rose 2.51% last week and has rallied ever since its low on October 5. 

•  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 High and Falling, which favors gold over bonds and then stocks.

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The major U.S. stock market indexes were down last week. The Dow Jones Industrial Average lost 1.61%, the Russell 2000 small-capitalization index dropped 2.26%, the S&P 500 decreased by 2.39%, and the NASDAQ Composite was down 3.16%. The 10-year Treasury bond yield rose 30 basis points to 4.91%, taking Treasury bonds lower for the week. Spot gold closed the week at $1,981.40, up 2.51%.

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 continues to trade in a downward bear-channel price structure following the peak set in late July. The Index is now trading right at its 200-day moving average and saw resistance at its 50-day moving average last week. Price is presently testing the swing low set in early October.

Several drivers were behind last week’s market sell-off. First, the market continues to assess multiple risks related to the Israel-Hamas war. At the forefront is uncertainty surrounding a potential Israeli ground invasion of Gaza. Additionally, and most notably, Treasury volatility continues, with the 10-year Treasury yield crossing 5.00% for the first time since 2007. Lastly, Federal Reserve Chairman Jerome Powell acknowledged that data does not indicate the Fed’s policy is currently too restrictive. However, on Thursday, Chairman Powell’s comments corroborated the popular view that the jump in long-term rates has helped tighten financial conditions.

With the NASDAQ up midday Monday, the Index is officially no longer in correction territory (defined as a decline of at least 10% from a closing high without a 10% rally in between). Bespoke Investment Group looked at historical trends for past NASDAQ corrections and how this period compares. Since hints of the current rate-hike cycle started, there have been four corrections in the NASDAQ prior to this one. The most recent decline before the current period was just over 11%; however, the other three experienced declines of more than 20%.

Taking a longer-term view, the following scatter chart shows corrections in terms of their magnitude (x-axis) and length (y-axis). Since 1977, the median decline of corrections has been 16.6% with a median length of 61 calendar days. The current decline is around 10%, which is less severe than the median magnitude. However, at 96 days, it’s currently 57% longer than the typical correction.

Since the July peak, the individual components of the S&P 500 have declined an average of 9.9%. However, many stocks have seen even larger drops. Additionally, fewer than 20% of the stocks in the Index have risen during this period, 81 of the stocks have decreased by 20% or more, and 166 of the stocks have declined between 10% to 20%.

The only sector with average gains among its components is Energy, which is up 5.4%. The only other sectors outperforming the S&P 500 Index are Technology, Financials, and Communication Services. Stocks in the Consumer Staples, Consumer Discretionary, and Real Estate sectors have declined the most since July 31.

The following chart takes another view of the data since the peak. It shows the percentage of components in each sector that posted positive returns since July 31. In five sectors, fewer than 10% of components have posted gains. Energy is the only sector where more than one-third of the components are up, with nearly 90% trading higher. Second place goes to Communications Services at just under 32%.

As market direction continues to trend downward, 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.

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.

The following chart shows the one-year performance of the Quantified Pattern Recognition Fund (QSPMX, 28.88%) compared to the SPDR S&P 500 ETF (SPY, 16.15%). The Quantified Pattern Recognition Fund dynamically trades the S&P 500, identifying and using mathematical patterns within the market to determine exposure. It has the flexibility to adjust its position daily, ranging from 100% inverse to 200% long. The Fund is used within some of our QFC strategies and can be used in our turnkey solution, QFC Fusion. Within our more customizable QFC Multi-Strategy Core and Explore turnkey solutions, QFC Multi-Strategy Explore: Special Equity has a current allocation to QFC S&P Pattern Recognition.

Bonds

The yield on the 10-year Treasury rose 30 basis points last week, ending at 4.91%.

The 10-year Treasury continues to trade in the upward bull-channel price structure that started in May. Also, price action has remained above the 50-day moving average, as indicated by the green line in the following chart.

With the rise in rates taking center stage once again, Bespoke Investment Group discovered that it has been 30 weeks since the 10-year Treasury experienced three straight weekly declines in yield. This is the third-longest streak since 2000. Last week, the 10-year Treasury hit its highest level since 2007, and the 30-year Treasury closed above 5% for the first time since that year. Although the long end of the yield curve has experienced the most selling, the two-year yield hit its highest level since 2006 last week.

On Thursday, Fed Chair Powell offered several possible explanations for what’s driving the selling of duration. He argued that the increase in long-term rates isn’t due to higher inflation expectations. The following chart shows that the 30-year yield has risen 123 basis points since rates started moving up on July 19. During this time, the spread between 30-year TIPS (Treasury Inflation-Protected Securities) and nominal yields (“breakeven” inflation pricing) has risen just 30 basis points. Rejecting inflation as a trigger for the yield increase, Powell proposed three potential causes: quantitative tightening, a strong economy, and market worries over deficits.

Gold

Gold rose 2.51% last week. The metal experienced a sharp drop in September but has rallied since October 6. It encountered no resistance at its 50-day moving average, and after briefly testing the 200-day moving average, it broke through strongly. Currently, its price is above the 50-day and 200-day moving averages, which are very close to each other.

September brought about a “death cross” (when the 50-day moving average crosses below the 200-day moving average), which is seen by technicians as a longer-term sell signal. However, if recent price action continues in its upward direction, a “golden cross” (when the 50-day moving average crosses above the 200-day moving average) could be in the cards 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.

The indicators

The very short-term-oriented QFC S&P Pattern Recognition strategy started last week with 40% short exposure. Exposure changed to 40% long at Monday’s close, moved to 10% short at Tuesday’s close, changed to 0% exposed at Thursday’s close, and changed to 40% long exposed 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 120% long exposure to the NASDAQ, changed to 140% long exposure at Tuesday’s close, changed to 120% long exposure at Thursday’s close, and moved back down 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 100% 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 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.