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: Last week, the major U.S. stock market indexes mostly rose, but small-cap stocks lagged. Positive Nvidia earnings spurred renewed enthusiasm around artificial intelligence.

•  Bonds: Treasury yields fell, with the 10-year Treasury yield ending at 4.25% but still above its 50-day moving average. Fed officials continued to maintain that they need sustained evidence to consider rate cuts.

•  Gold: Gold rose 1.08% last week and is currently trading at the upper trend line in a bear price channel.

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

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The major U.S. stock market indexes were mostly up last week. The S&P 500 increased by 1.66%, the NASDAQ Composite was up 1.40%, the Dow Jones Industrial Average gained 1.30%, and the Russell 2000 small-capitalization index fell 0.79%. The 10-year Treasury bond yield fell three basis points to 4.25%, taking Treasury bonds higher for the week. Spot gold closed the week at $2,035.40, up 1.08%.

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 continued its positive momentum, setting new all-time highs again last week. The Index is trading well above its 200-day and 50-day moving averages. Since the October low, the market has experienced very little selling pressure, with all pullbacks so far being short and shallow.

Last week, the NASDAQ shifted into rally mode, and the S&P 500 and Dow Jones Industrial Average advanced further into record territory. The move was driven by Nvidia (NVDA) earnings, which spurred renewed enthusiasm around artificial intelligence (AI). Small-capitalization stocks underperformed, with most of the focus being on technology and mega-cap stocks. Investors’ fear of missing out on further gains added to the rally last week.

With markets rallying so far this year, Bespoke Investment Group conducted a study highlighting similarities to past market trends and the effect of AI on markets and investor positioning. The technical and fundamental landscape remains pretty clear: upward momentum with little volatility. Economic fundamentals have been quite strong, and earnings have been free of major negative surprises. Investors have been expecting imminent rate cuts, but the Federal Reserve has reiterated the need for evidence before considering a shift in policy.

Last Thursday was the first time since March 21, 2000, that the S&P 500 saw a 2%-plus daily increase and closed at an all-time high. Throughout the bull market rally of the 1990s, this happened nine times. Between 1952 and 1989, it occurred on 11 occasions.

The following chart shows that these big moves to new highs typically occur in the midst of strong bull markets rather than at the end. One exception was the last instance in March 2000. The green dots on the chart represent days when the S&P 500 was up more than 2% and at all-time highs. The table shows how the Index performed in the days and weeks following such events. Typically, markets experienced a short-term pullback. The next day, week, and month have averaged a small decline. Beyond three months, markets have historically resumed their move higher.

During the 1990s, the NASDAQ 100 experienced over 30 one-day gains of 3% or more to close at all-time highs. The fact that the last occurrence took place in March 2000 indicates that there is still room to run when considering historical patterns.

In early February, Bespoke compiled a list of AI stocks in the S&P 500 by examining eight popular AI ETFs and finding S&P 500 names included in them. Out of all of the stocks included in the S&P 500, 67 stocks fit the criteria, providing a good way to compare large-cap AI stocks to the rest of the Index.

The following chart shows that since the release of ChatGPT on November 30, 2022, the 67 S&P 500 AI stocks have averaged a gain of over 45%. The remaining 433 stocks in the Index have averaged a gain of 8.08% over the same time frame. Year to date, AI stocks are up an average of 4.34% compared to a gain of 2.29% for non-AI stocks. Since Nvidia (NVDA) reported earnings last Wednesday, the 67 AI stocks are up an average of 2.04% compared to 1.13% for the 433 non-AI stocks.

The Bespoke team looked at historical parallels to help gauge whether the run we’ve seen is more similar to the early to mid-1990s, when the internet boom began, or the late 1990s, toward the end of the dot-com bubble. They studied the NASDAQ’s performance in the first few years following major historical technological releases to draw comparisons with the current ChatGPT rally. The following major technological releases are plotted on the time-series chart below:

•  First MS-DOS operating system for the PC: August 1981

•  Release of America Online (AOL): February 1991

•  Release of Netscape web browser: December 1994

•  Release of the iPod: November 2001

•  Release of Myspace: August 2003

•  Release of the iPhone: January 2007

The following chart shows how the NASDAQ performed in the next three years after each of those major technological releases. The rally since the release of ChatGPT looks most similar to the movement following the December 1994 release of Netscape.

Last Friday (February 23) marked 309 trading days since the release of ChatGPT, during which time the NASDAQ has surged over 46%. Comparatively, 309 days after the release of Netscape, the NASDAQ had climbed by 45.9%. Interestingly, the Index’s price action in the first 309 days following the ChatGPT release also resembles the price action after the 1991 release of AOL. In hindsight, the NASDAQ’S rally was just beginning after AOL and Netscape came out. Investors are now thinking that we are in the early stages of an AI boom.

AI is not only a hot topic among investors but has also seen a rise in mentions during mega-cap conference calls in recent years. However, this past quarter, the number of AI mentions was down from Q3, marking the first quarter-over-quarter decrease since the first quarter of 2022. Amazon (AMZN), Meta (META), and Nvidia (NVDA) all mentioned AI less this quarter than last, while Apple (AAPL) has yet to mention AI directly in terms of its business. On the other hand, Microsoft (MSFT) and Alphabet (GOOGL) increased their discussion of AI this quarter compared to the last.

The longer-term upward trend that began in October has not shown signs of reversing. 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 momentum that began in October loses steam and prices face increased selling pressure more indicative of 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 compares the year-to-date performance of the Quantified Pattern Recognition Fund (QSPMX, 12.43%) to the SPDR S&P 500 ETF (SPY, 6.89%). 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 (such as our QFC S&P Pattern Recognition strategy) and can be used within our more customizable turnkey solutions, such as our QFC Multi-Strategy Core and Explore offerings. Our QFC Multi-Strategy Explore: Special Equity strategy is currently weighted heavily to QFC S&P Pattern Recognition.

Bonds

The yield on the 10-year Treasury fell three basis points last week, ending at 4.25%.

The 10-year Treasury has been advancing since its late December low when it was yielding less than 4%. The 10-year Treasury traded through its 50-day moving average in early February. The slope of its 50-day moving average is turning positive while price action remains above the 50-day moving average.

T. Rowe Price traders reported, “In a speech delivered on Thursday, Federal Reserve Board Governor Christopher Waller opined that higher-than-expected inflation in January, along with the tight jobs market and the economy’s strength in the fourth quarter, ‘reinforced his view that we need to verify that the progress on inflation we saw in the last half of 2023 will continue.’ Waller believes that inflation is ‘likely’ to return to the Fed’s 2% target. But he also cautioned that he’d like at least a few more months of data to see ‘whether January was a speed bump or a pothole.’”

Gold

Gold rose 1.08% last week but continues to trade inside a bear price channel that started at the end of last year (shaded region on the following chart). Gold is currently trading at the top of the bear price channel. If the channel remains intact, it wouldn’t be surprising to see price movement back around its 200-day moving average. The “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, is still in play. However, the 50-day moving average is now sloping downward.

This technical pattern typically grabs technicians’ attention due to two scenarios: 1. The long case involves a breakout of the upper trend line and the failure of prices to reenter the price pattern. 2. The short case entails a strong leg down following expected support at the lower trend line and possibly the 200-day moving average. Technicians are monitoring future price action at the 200-day moving average for signs that the longer-term trend has momentum to reverse.

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 Tuesday’s close, 120% long at Wednesday’s close, and 70% long at Thursday’s close. Our QFC Political Seasonality Index was defensively positioned 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 160% long exposure to the NASDAQ and changed to 120% long exposure 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 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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