Market insights and analysis

By Jerry Wagner

The major market indexes finished mixed last week. The S&P 500 Index slipped 0.3%, the NASDAQ Composite gained 0.6%, and the Russell 2000 small-capitalization index rose 1.5%. The 10-year Treasury bond yield increased 7 basis points to 3.812% and bonds weakened in price. The U.S. Aggregate Bond ETF (AGG) dropped 0.4%, and the 20-year Treasury bond ETF (TLT) tumbled 1%. Gold futures closed at $1,851.80, down $22.70 per ounce, or 1.2%.

Stocks

While stocks continue to be above their 200-day moving average, the last five days have witnessed a drawdown from the new recovery high in the S&P 500 made just a week before. Since that high, every sector of the S&P has fallen daily (through Tuesday, February 21, 2023), and all of the other major equity indexes have fallen too.

The declines have been due to a combination of good and bad economic reports. All of them seem to turn up the heat, sparking Wall Street’s worst fears for the markets.

On the good side, retail sales and employment reports have been better than expected. Good news, but it also stokes the fears that the Federal Reserve will see the economy as being strong enough to sustain even greater interest-rate pressure.

On the other side of the ledger, inflation reports of both the consumer price index (CPI) and the producer price index (PPI) were at or above expert estimates, reigniting the inflation fears that have gripped the nation for most of the last 12 months. At the same time, last week’s report from the Philadelphia Fed Business Outlook Survey showed readings of less than the -20% level that have always resulted in a recession. Similarly, the Index of Leading Economic Indicators has also fallen to levels where a recession has always occurred. Our predictions last year of a likely double-dip recession seem more and more prescient.

The precipitator of the bad news and the likely result of the good news has been an aggressive Federal Reserve that has pushed rates ever higher. Emblematic of this is the six-month Treasury bill rate. It has now surged past the 5% mark.

It cannot be denied that when you can make 5% on your money in the safety of a government bond, it is hard to take on the risk of an equity market investment. Yet it is out of such markets that stock market bottoms are formed. But it is usually not without bouts of short-term downside volatility like what we have experienced over the last five days.

Despite the inflation fears, an objective eye would view the stock market as being in fairly good shape. It seems better prepared for a rally than a correction. Perhaps the market internals and the inflation fears balance out. That balance could be the reason for the current short-term volatility, as well as the sideways consolidation that we see in the S&P chart of late, in contrast to the strong January we experienced.

Strong Januaries do tend to lead to a strong finish to the year, with an average gain topping 10% in such situations. But Februaries tend to be flat to down, and this year’s version is proving to be no exception to the rule. In contrast, March and April are two of the market’s best-performing months, an effect as strong over the last 20 years as over the last 100. Only the three-month year-end period is better.

Back to the stock market’s internal strengths: We have seen isolated incidents of poor response to market earnings (Walmart and Home Depot are good examples this week), but, as a whole, the market has been reacting better than it has in recent years to earnings—be they good or bad. Fourth-quarter earnings and revenues have been beating analyst estimates at a slightly better rate lately as well (although if we isolate just the S&P 500 stocks, earnings beats have been below average).

Advance/declines, highs and lows, and credit spreads are all used to measure the internal strength of the market. Here, too, the numbers confirm that we are in rally mode. Even the NASDAQ bottom-finder indicator, which has been holding out giving its blessing to a market breakout, has given a buy signal.

Finally, measures of market sentiment are no longer at the deep levels of pessimism that we saw at the end of 2022, levels which marked the bottom of the market correction, so far. While this contrarian boost to the market is gone, we are not at bullish levels of optimism or complacency that we would normally see at a market top.

Bottom line: We have moved out of the phase where outright market pessimism ruled the day. Buying during such conditions is hard but is usually profitable, as it has been for many of our stock market strategies this year. At present, however, crosscurrents created by economic reports are calling into question the market assumption that the Fed would be moderating or ending its interest-rate tightening. At the same time, the strong January gains are enough to cause a pause as the market absorbs its moderately overbought conditions. In addition, a final retest of last year’s stock market bottom cannot be totally dismissed as the market slowly realizes the true risks of a double-dip recessionary market like the one experienced in the 1980s.

Bonds

The celebrations marking the new year have long passed, and the optimism of bond investors expecting a softening by the Federal Reserve has faded away. Now, like partygoers awakening after a night of revelry, bond investors have a hangover that just won’t quit.

As the previous chart demonstrates, bond yields fell until the beginning of February, when they hit their 200-day moving average and reversed. Thereafter, they have moved practically straight up, breaking easily through both their 20-day and 50-day moving averages to set a new short-term high last week.

Like stock market prices, bond prices have felt the weight of rising yields. They, too, have turned in their tracks. Fortunately, with high yields to support them, and the resulting increased demand, they have not fallen as drastically as yields have risen or stocks have fallen. However, the way that they stopped at, and failed to overcome, their 40-day moving average last week suggests that further declines may soon be in the offing.

The high-yield sector of the bond market has stalled with the stock market. It looks to be running out of steam after making a nice run-up following its breakthrough above its 40-day moving average at the end of last year.

Gold

Gold has been in a long rally since the first of November. It has spent three months above its 50-day moving average. But last week it broke below that average price line, ending the current rally mode.

Once again, the cause of gold’s price movements can be laid at the U.S. dollar’s doorstep. Rising yields are supportive of a higher dollar as foreign accounts need our dollars to obtain our higher and safer yields. As discussed in the Bonds section, yields have moved higher as bond investors have rethought their optimism in the face of stronger economic reports and longer/higher-than-expected rates of inflation.

Just as gold has broken below its moving average, the dollar has surpassed its own. This plus the comparative opportunity cost imposed on gold versus bonds (the precious metal has no yield and has storage costs) may mean that the pause in gold’s rally may persist for a while, at least until the Fed makes clearer the extent and duration of its rate-raising intentions.

Flexible Plan Investments (FPI) is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction more than nine years ago to track the daily price changes in the precious metal.

The indicators

The very short-term indicators for stocks that I watch are bearish, while the midterm indicators continue in a bullish mode. The short-term-oriented QFC S&P Pattern Recognition strategy, after grabbing some gains on the short side of the market, has moved to 170% exposed to the S&P 500 Index.

Our QFC Political Seasonality Index (PSI) strategy had been fully invested but sold on Thursday’s (2/16/23) close. Thereafter, the PSI embarks on a very choppy period as it buys back in on February 22, sells on February 24, and then returns to equities on February 28. It will remain on the offensive until March 16, when it will go for a short time to its defensive positions.

Our QFC Political Seasonality Index strategy was one of our top-performing strategies for 2022. The strategy is available separately and is also included in our QFC Multi-Strategy Explore: Special Equities and QFC Fusion portfolios. (Our QFC Political Seasonality Index calendar—with all of the 2023 daily signals—can be found post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.)

FPI’s intermediate-term tactical strategies continue to be mixed. Classic remains fully invested in equities. The Volatility Adjusted NASDAQ (VAN) strategy is neutral and defensively positioned, the Systematic Advantage (SA) strategy is 30% in equities, and our QFC Self-adjusting Trend Following (QSTF) strategy is positioned 100% in the NASDAQ. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Flexible Plan’s Growth and Inflation measure is one of our Market Regime Indicators. It shows that we remain in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and 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 equities from an annualized return standpoint. The combination has occurred 13% of the time since 2000.