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 

•  The major U.S. stock market indexes were mixed last week, with mega-cap stocks leading and small-cap stocks lagging. Equity markets attempted to break out of their downward bear-channel price structure. 

•  Treasury yields rose slightly, but the 10-year Treasury is trading well below its 5% peak from October. 

•  With rates off peaks, homebuilders have rallied over 15% over the past couple weeks. 

•  Gold fell 2.63% last week, experiencing a pullback in the rally that started in October, currently testing its 200-day moving average. 

•  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 historically one of the best stages for stocks, with limited downside. The S&P volatility regime is registering a High and Rising reading, which favors equities over gold and then bonds.

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The major U.S. stock market indexes were mixed last week. The Dow Jones Industrial Average gained 0.65%, the Russell 2000 small-capitalization index dropped 3.15%, the S&P 500 increased by 1.31%, and the NASDAQ Composite was up 2.37%. The 10-year Treasury bond yield rose 8 basis points to 4.65%, taking Treasury bonds lower for the week. Spot gold closed the week at $1,940.20, down 2.63%.

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 maintained price action above its 50-day moving average and above its upper trend line of the downward bear-channel price structure. The Index is also trading above its 200-day moving average and saw little resistance at its 50-day moving average last week. If prices remain at these levels or higher, a 50-day and 200-day “death cross” looks to be off the table at present.

Mega-cap stocks drove most of market gains last week, with the Vanguard Mega Cap Growth ETF (MGK) up 3.40%, while the Invesco S&P 500 Equal Weight ETF (RSP) was down 0.6%. Since its low on October 27th, the S&P 500 Index is up 7.2%. Largest losses were seen in the small-cap space, with losses over 3.0% for the Russell 2000 Index. Market momentum was slowed by a rise in rates following Treasury auctions last week and from commentary from Federal Reserve Chairman Powell. On Thursday during an IMF panel discussion, Mr. Powell reiterated his remarks from November 1st, stating “if it becomes appropriate to tighten policy further, we will not hesitate to do so.”

With momentum turning in recent weeks, Bespoke Investment Group notes that technicals have gone from bearish to neutral for both the S&P 500 and the NASDAQ 100. The chart below shows the NASDAQ broke above the top of its downtrend channel earlier this week. For technicals to flip from neutral to bullish, the highs from July will need to be taken out. To achieve those levels, the NASDAQ 100 will only need to gain another 2%. The S&P 500 is about 4% away from its July 31st peak.

As equities fell from July 31st through October, rates experienced a big move higher. The recent bounce in stocks coincided with a pullback in Treasury yields. Last week, the 10-year Treasury yield broke below its 50-day moving average, and is currently testing for support at the 50-day level.

Homebuilders rallied on the drop in rates, seeing a four-day move higher of 15.2%. The 15%+ rally was the strongest since the early days of the post-COVID bull market in 2020. Even with this recent move, homebuilders remain well below 2023 highs, if rates continue lower, we could see a test of yearly highs for homebuilders.

Higher yielding fixed-income products have provided competition to high dividend stocks, which continue to struggle in 2023. The chart below shows that the 100 highest yielding S&P 500 stocks at the start of the year are down an average of 7.94% year-to-date on a total return basis. This is compared to an average gain of 8.94% for the 100 stocks that had no dividend yield at the start of this year.

Since the first Federal Reserve rate hike on 3/16/2022, the S&P 500 Index is up 3.2%, while the iShares Dividend ETF (DVY) is down a whopping 10.2%

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We are now a year out from the 2024 presidential election. Bespoke Investment Group updated their S&P 500 four-year presidential election cycle composite chart. The current Biden cycle has played out very similar to the average path. A strong 1st year, difficult 2nd year, and a strong 3rd year. Year 4 isn’t historically quite as strong as year 1 and 3, but has, on average, yielded gains. Flexible Plan offers strategies that focus on seasonal and political patterns in markets, specifically related to the political cycle. QFC Political Seasonality Index incorporates over 100 years of market data to project the year’s trades based on presidential and seasonal cycles. 

Aside from political cycles, QFC Pattern Recognition takes into account more near-term mathematical patterns in markets. Since the July peak in markets, we’ve seen a comeback in the After-Hours vs. Regular Session trading methodology. Historically, most of the gains in the S&P 500 have come from moves outside of regular trading hours. For most of this year, though, the market was generating gains primarily from the regular session.

Since July 31st however, the after-hours move has been much stronger than earlier this year and provided more gains than the intraday-move approach. As shown below, if you only owned the S&P 500 outside of regular trading hours since 7/31, you would be up 1.7%, while holding only during regular trading hours, you’d be down 5.7%.

As markets continue to search for longer-term direction, 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.

If consistent tradable patterns emerge, our short-term term tactical strategies like QFC Pattern Recognition will dynamically adapt to changing conditions via its routine walk-forward optimization. During this time, optimal patterns to search for are selected and utilized. If markets are more “trending”, there will be a slight bias to trending-style patterns. If no trend emerges and markets resemble a mean-reverting environment, the strategy will be more biased to capitalizing on faster, more mean-reverting patterns in markets.

The following chart shows the one-year performance of the Quantified Pattern Recognition Fund (QSPMX, 21.54%) compared to the SPDR S&P 500 ETF (SPY, 19.65%). 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 2.0. 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 8 basis points last week, ending at 4.65%.

The 10-year Treasury continues to trade in the upward bull-channel price structure that started in May, but has experienced a significant pullback. Currently, the 10-year is searching for support at its 50-day moving average. Since the breakout in May, price action has remained above the 50-day moving average, as indicated by the green line in the following chart.

T. Rowe Price traders reported, “The tax-free municipal market felt the impact of higher yields but benefited from heavy oversubscription on many of the new deals that came to market during the week. Heavy new issuance in the investment-grade corporate bond market was also met with healthy demand. Buyers in the high yield bond asset class appeared somewhat more selective, according to our traders, but higher-quality bank loans continued to see solid demand.”

Gold

Gold fell 2.63% last week. The metal experienced a sharp pullback last week, the first one since the rally started on October 6. Prices pulled back right to the 200-day moving average, currently testing it and searching for support. The 50-day moving average is not far below. 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 following this pullback, 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 80% short exposure. Exposure changed to 110% short at Monday’s close, moved to 120% short at Tuesday’s close, changed to 170% short exposed at Wednesday’s close, changed to 160% short at Thursday’s close, and changed to 50% short 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 40% long exposure to the NASDAQ, changed to 100% long exposure at Wednesday’s close, changed to 120% long exposure at Thursday’s close, and moved back down to 100% long at Friday’s close. The Systematic Advantage (SA) strategy is 0% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 100% long throughout last week, changing to 200% long at Friday’s close. 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 Rising reading, which favors equities over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2000. It is a stage of lower returns and higher volatility for all three major asset classes.

 



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