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 up last week. Equity markets continue to trade at 52-week highs with little selling pressure seen since the start of October’s rally. The S&P 500 could see momentum continue when taking a less noisy day-to-day view of market price action and if broader asset-class relationships continue.

•  Bonds: Treasury yields rose slightly, but the 10-year Treasury yield has pulled back significantly (~5%) from its October peak, ending last week at 4.23%.

•  Gold: Gold fell 3.26% last week, experiencing its second 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 Falling, which favors stocks over gold and then bonds.

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The major U.S. stock market indexes were up last week. The Russell 2000 small-capitalization index rose 0.98%, the NASDAQ Composite was up 0.69%, the S&P 500 increased by 0.21%, and the Dow Jones Industrial Average gained 0.01%. The 10-year Treasury bond yield rose 3 basis points to 4.23%, taking Treasury bonds lower for the week. Spot gold closed the week at $2,004.67, down 3.26%.

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 now trading at new 52-week highs, experiencing very little selling pressure following the bottom set in late October. The Index is trading well above its 200-day and 50-day moving averages. Conviction hasn’t been strong from either buyers or sellers, with investors feeling a growing sense that the stock market is overbought on a short-term basis. Following last week’s data, the fed funds futures market is no longer pricing in a March rate cut, but the CME FedWatch Tool is showing a 78.5% probability of a cut in May.

With markets significantly up since October lows, taking a longer-term perspective on things makes sense. It would be expected that prices should pull back during this upward move, providing some relief to these overbought conditions. It is also possible that markets trade to all-time highs set in January 2022 since those levels aren’t that far away from current price action.

Bespoke Investment Group looked at historical data going back to 1991, specifically cycles for the S&P 500’s 200-day moving average. Viewing only the 200-day moving average instead of daily prices eliminates the day-to-day noise of markets and gives you a smoothed-out view, which helps to better gauge the market’s ultimate trend at any point in time. Currently, the 200-day moving average has had a chance to round out a significant bottom and start heading higher again. Markets are now more than a year from the 2022 bear market and up around 30% from bear market lows. The 200-day moving average hasn’t taken out prior all-time highs yet, but you can see that the 200-day has turned in its cycle, similar to the dot-com crash and 2008 financial crisis.

The “three-headed monster” of Treasury yields, the dollar index, and oil prices experiencing short-term downtrends has been music to the ears of equity market bulls. The 10-year Treasury, oil, and the dollar are all well below their 50-day moving averages

Friday’s economic release showed 199,000 jobs created in November, versus expectations of 185,000; manufacturing jobs bounced back due to the end of the United Auto Workers strike. Household employment rose by a much stronger 483,000. The average across the two is the strongest since July.

The uptick in the household survey’s job numbers led to an unemployment rate of 3.7%, below the 3.9% estimated. Bespoke’s “total labor slack” measure fell from 9.3%, which is the highest since May 2022, to 9.0%. Given how big monthly swings can be in the household survey, one shouldn’t rely solely on this one report. The biggest takeaway is that labor markets are trending toward equilibrium in terms of payrolls, joblessness, and wages. Most importantly, the Federal Reserve makes fed funds rate decisions based on economic data to achieve their dual mandate of maximum employment and stable prices, so seeing how the employment data is trending can give us insight into market expectations.

Homebuilders continue to rally. The following chart shows that the S&P 1500 Homebuilder group has gained 32% since its low in October. For context, this increase is about 20% higher than the gain the S&P 500 has seen from its October low. Furthermore, with a 62.5% rise in 2023, this marks the fourth-best year for the S&P 1500 Homebuilder group since 1995.

Homebuilders have rallied for much of the year amid rising interest rates. However, the recent spike coincides with the sharp drop in interest rates, possibly suggesting a material intermediate trend shift in underlying expectations.

As market direction continues to trend upward, 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 current momentum loses steam and prices begin experiencing selling pressure more synonymous with a “correction” rather than a “pullback.”

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 STF Fund (QSTFX, 46.92%) compared to the Invesco QQQ Trust (QQQ, 40.79%). The Quantified STF Fund dynamically trades the NASDAQ 100. The Fund identifies long-term trends within the market to determine exposure, ranging from inverse to a max exposure of 200% long. It also has the flexibility to adjust its position daily. The Fund is used within some of our QFC strategies and can be used in our turnkey solutions. QFC Multi-Strategy Explore: Equity Trends is currently overweight the QFC Self-adjusting Trend Following strategy. The Fund moved from 100% long to 200% long in early November and is still positioned at maximum long exposure.

Bonds

The yield on the 10-year Treasury rose 3 basis points last week, ending at 4.23%.

The 10-year Treasury peaked on October 19 and pulled back significantly, breaking out of its upward bull-channel price structure that started in May. This sharp move down saw no support at its 50-day moving average. The 10-year is more than 20 basis points from retesting the 4.00% level.

T. Rowe Price traders reported, “The investment-grade corporate bond market weakened relative to Treasuries among softer tones in the beginning of the week. Issuance came in slightly above expectations, and about half of the issues were oversubscribed. … High yield bond investors were mainly focused on the very active primary market, as companies looked to refinance debt or issue new deals before year-end. Demand was especially strong for BB rated bonds with attractive coupons.”

Gold

Gold fell 3.26% last week. The metal started December with a sharp drop, but this came after a significant rally off early October lows. Gold is encountering its second pullback during this rally. Recent upward price action has led to a “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.

However, the price of gold is close to both its 50-day and 200-day moving averages, so further selling could flip the signal back to 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. Nothing suggests that this sell-off isn’t a standard pullback within a longer-term uptrending bull-price channel. One of the first signs to watch out for is the failure to make a higher high in this channel once prices trade upward. If a new high is established that is lower than the one on December 1, 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 0% exposure. Exposure changed to 40% long at Wednesday’s close, moved to 90% long at Thursday’s close, and changed to 60% long at Friday’s close. Our QFC Political Seasonality Index favored stocks through Wednesday last week and moved to more defensive positioning at Wednesday’s close. (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 180% long exposure to the NASDAQ, changed to 160% long exposure at Monday’s close, changed to 200% long exposure at Tuesday’s close, and moved to 140% long at Thursday’s close. The Systematic Advantage (SA) strategy is 120% 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 Falling reading, which favors stocks over gold and then bonds from an annualized return standpoint. The combination has occurred 37% of the time since 2003. It is a stage of higher returns and lower volatility for stocks relative to the other volatility regimes.



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