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 Will Hubbard

Market snapshot

•  Stocks: The major U.S. stock indexes were up last week. The U.S. stock market is in a phase of the presidential election cycle that has been historically profitable.

•  Bonds: Bond yields have come down in recent weeks and could see further gains if the Fed cuts interest rates throughout 2024.

•  Gold: Gold closed at unadjusted all-time highs. Adjusted for inflation, there is still room to climb.

•  Market indicators and outlook: Market regime indicators show we are 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 indexes were up last week. The Russell 2000 small-cap index gained 2.41%, the NASDAQ rose 2.31%, the S&P 500 increased by 1.37%, and the Dow Jones Industrial Average climbed 0.04%. The U.S. 10-year Treasury ticked up 16 basis points to close at 4.18%. Gold fell 0.765%.

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

Last week, the major U.S. stock market indexes rallied, including the S&P 500 Index, which is currently 19% above its October 2023 low.

It was a light week for economic data. The key updates focused on wholesale inventories, unemployment claims, and mortgage delinquencies.

Wholesale inventories were in line with expectations, coming in at 0.4% last week. This measure tells us how much the value of goods that wholesalers hold has changed. It’s important because it can signal whether businesses are buying more stock either because they’ve sold what they had or they think they’ll sell more soon. Right now, the reading isn’t indicating a pickup or a slowdown.

The current market narrative is upbeat. Nothing seems to be preventing stocks from moving higher other than historically stretched fundamentals and worries about the upcoming presidential election. If you are concerned about the effect of the upcoming presidential election on your portfolio, check out last week’s Market Update by Tim Hanna for an in-depth analysis of how to approach this year. As far as the fundamentals go, the market has been stretched since around 2018 when the Q ratio, or Tobin’s Q, jumped more than one standard deviation above its long-term average.

Tobin’s Q, devised by economist James Tobin, suggests that the value of a company should be equal to the cost to replace it. This concept means that the market reflects the combined value of all businesses. Investors may see this as theoretical, but the premise makes sense: During optimistic times, people are willing to pay more to own companies than during periods of crisis.

Tobin’s Q is useful as a long-term indicator, offering insight into the market’s position relative to its extensive history. However, it’s not great for “timing” the market because of its delayed response. As recent history shows, markets can remain optimistic and overextended for a long time, and missing out on the market for the last three years, for example, would have been a mistake.

Another reason for short-term optimism is the continued low number of unemployment claims. The latest data came in just below expectations: Forecasts predicted 221,000 claims, but the number came in at only 218,000. The jobs market is so strong that it’s unlikely the Federal Reserve will be able to lower interest rates soon. If job numbers and inflation stay strong, we can expect the Federal Reserve to hold rates steady.

The Associated Press reported that Fed Chairman Powell recently said in an interview that “the nation’s job market and economy are strong, with no sign of recession on the horizon.” This raises the question: If the economy is so strong and everything is going so well, then why do we need to be so focused on cutting rates? If our economy can support the current interest-rate environment without struggling, then lowering rates might just increase activity and hike inflation again. In the short term, it is causing bond rates to fluctuate.

Bonds

The yield on the 10-year Treasury rose 16 basis points from 4.02% to 4.18%.

In October 2023, the 10-year Treasury peaked just below 5%. Since then, Federal Reserve policymakers have hinted that they expect short-term rates to start dropping in the second half of 2024. This has led investors to bid higher for bonds, aiming to “lock in” the current rates. As a result, the 10-year rate fell to about 3.8% in January this year, before finishing last week at 4.18%.

One popular strategy in the past year has been to invest in short-duration money-market funds. For years, these funds didn't offer much more return than keeping cash in a savings account. But with the Fed’s aggressive rate hikes, their yields are now topping 5%. However, many investors might not be aware of the reinvestment risk involved. Nearly all of the underlying holdings of money-market funds will mature in a month or two, making these investments sensitive to the short-term interest-rate environment. If rates drop, money-market yields will quickly follow suit, leaving investors little time to change their strategy or opt for longer-term investments. It’s wise to anticipate a potential rate decrease and consider its effects on stocks and bonds now.

Gold

Gold lost 0.76% last week, finishing at $2,024.96 per ounce. This is still above the $2,000-per-ounce level that gold bulls covet.

Some traders believe the recent drop in gold prices is linked to the strong rally in the stock market. They point to the CME FedWatch tool, which shows a 57% probability of a rate cut in May, as support for investors’ move into equities.

According to Reuters, Bart Melek, the head of commodity strategies at TD Securities, predicts that “strong physical demand and official sector buying are projected to lift [gold] prices to an average of $2,200/ounce next quarter,” even without any rate cuts.

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 and ended last week in cash. The algorithm didn’t find any short-term patterns to capitalize on. Our QFC Political Seasonality Index spent most of last week in its risk-off posture, switching to its risk-on position at the close on Friday (2/9). (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 last week 120% long and increased exposure to 140% long on Monday’s close where it finished the week. The Systematic Advantage (SA) strategy started the week 120% long and reduced exposure to 60% long on Monday’s close. On Wednesday, the strategy moved back to 120% long where it ended the week. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long all week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic model was long risk-on positioning all 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 more restrictive platforms and can take up to one month to generate a new signal.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, shows markets are in a Normal economic environment stage (meaning inflation is falling and GDP is growing). 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.

The S&P volatility regime is registering a Low and Falling reading, which favors stocks over gold, and gold over bonds from an annualized return standpoint. The combination has occurred 37% of the time since 2003. Typically, this stage is associated with higher returns and less volatility from equities and bonds.



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