By Will Hubbard The major U.S. stock indexes declined last week. The S&P 500 dipped 2.67%, the Dow Jones Industrial Average lost 2.99%, the NASDAQ Composite dropped 3.33%, and the Russell 2000 small-capitalization index lost 2.87%. The 10-year Treasury bond yield moved up 13 basis points to 3.94%. Spot gold closed the week at $1,811.04, down 1.70%. Stocks The holiday-shortened week brought a statement from the Federal Reserve and news on gross domestic product (GDP) growth and personal consumption. The culmination of these reports spooked the market and caused a sell-off. Of concern is whether the Fed has a handle on inflation and if equity markets have truly priced in a recession. On February 22, the Fed released its meeting statement (dated February 1, 2023), which says, in part, “Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated.” Essentially, the Fed is saying that inflation appears to be slowing, but the job market is so strong that it may be causing inflation to stay a little higher than usual. This has been a consistent message from the Fed, and it might not have been a concern on its own had the second estimate for Q4 2022 GDP not followed the next day. In the fourth quarter of 2022, the annualized GDP estimate was expected to be 2.9%. It came in at 2.7%, indicating the economy slowed more than economists originally anticipated. A recent report from The Conference Board shows its Leading Economic Indicator Index (LEI) contracted 3.6% between July 2022 and January 2023, a sharper decline than between January 2022 and July 2022. The declines come on the heels of substantial post-COVID growth culminating in a peak around mid-2021. According to research by The Conference Board, the LEI at these levels signals a recession occurring in the next 12 months. Slowing GDP is not a good sign, but it could be a short-term blip before things pick up again. Friday’s personal consumption expenditures (PCE) report didn’t ease concerns about inflation or the economy’s ability to weather a slowdown. The PCE report showed that personal income increased by 0.6% (monthly), while consumer spending grew at 1.8%. The mismatch between income and spending exacerbated market fears that things are not as rosy as hoped. The Fed prefers PCE as a measure of inflation. With Friday’s hot print, the fear is that the Fed will take more aggressive action (i.e., raise rates more than expected), which could further hinder an economy that seems to be on life support. The narrative is further challenged by goods and services inflation issues, but we’ll leave that for our discussion on bonds. For equities, the challenge this year is clear: What does it take to stay invested and focus on earning a return while minimizing downside risk? There are a few ways to do this, but all of them involve taking an active approach to managing your future well-being. People that follow the passive, hands-off-the-wheel approach will tell you a 30-year breakeven is OK. I’m sure investors in Japan’s Nikkei would beg to differ. As the following chart shows, the Nikkei peaked in 1989. Bonds Last week seemed a lot like déjà vu with inflation and the Fed dominating headlines. The 10-year Treasury declined in value last week after a rate increase of 0.13%, bringing it from 3.81% to 3.94%. For the last decade, the mantra was “don’t fight the Fed.” Now, the Fed says it’s going to raise rates to battle inflation and keep rates higher until inflation subsides. For the last year, the markets and pundits seemed to have forgotten the mantra and are now determined to fight the Fed. The core consumer price index (CPI) remains elevated. Goods inflation is improving, while services inflation remains elevated. Three weeks ago, Federal Reserve Chairman Jerome Powell said that the “disinflationary process” has begun. The pace of inflation is indeed slowing, and the economy is acclimating to these new levels, but that’s also due to the base effect. The prices from a year ago are elevated, so this year’s increase only looks smaller when compared to last year’s much larger increase. The Fed faces the unenviable task of trying to slow an already anemic economy. Economic theory says that inflation occurs due to an overheating economy—too much demand for too few goods. To battle inflation, according to the theory, you need to slow the economy or cause a recession to reduce demand and let prices stabilize. This would be fine if the economy was running hot, but it isn’t. Currently, unemployment is at a very low 3.4% and real GDP growth is forecast to be 1.4% in 2023. Most economists are forecasting a recession. The reason this is an issue is that while the headline CPI (red line in the previous chart) is moderating, core goods (green line) are coming back quickly, and services (yellow line) are still trending up. This makes the Fed’s job even more difficult, as it tries to avoid raising rates too high and too fast. Gold Gold ended last week down 1.70% at $1,811.04 per ounce. The metal started the year off strong, ending January up nearly 5%. Around the same time, the U.S. dollar found its footing and rallied as the equity market faltered. The multiyear inverse correlation between the yellow metal and the beloved greenback continues, with the U.S. dollar finding strength throughout February, reducing gold’s year-to-date return from nearly 6% to a small loss of 0.71%. Chairman Powell’s approach to interest rates will likely impact both the dollar and gold. It will be interesting to see how this relationship develops as the year, and rate changes, continue to unfold. Flexible Plan Investments is the subadviser 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-oriented QFC S&P Pattern Recognition strategy started last week 70% long. On Tuesday’s close, it increased to 140% long. On Wednesday, it moved to 180%. On Thursday, it took risk down to 50% before closing the week out 30% long. Our QFC Political Seasonality Index started the week in defensive positioning and moved into equities at Wednesday’s close. The strategy moved back to defensive positioning at the close on Friday. (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 in cash before moving 20% short on Wednesday’s close. The strategy took profits and moved back to cash on Thursday. The Systematic Advantage (SA) strategy started last week 60% exposed to the S&P 500 before moving to 30% exposed on Tuesday’s close. On Thursday’s close, Systematic Advantage moved to 90% long. Our QFC Self-adjusting Trend Following (QSTF) strategy was long 100% 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 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 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 rising and GDP is growing). This environment is the most common—accounting for 60% of the investable days since 2003—and favors stocks and gold. On average, gold has performed best during Normal market environments, but it comes with additional drawdown risk. 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. It is a stage of relatively high returns and lower volatility for the three major asset classes.