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 market took a breather from its recent AI-driven surge. The major U.S. stock market indexes were mostly down due to consolidation, but small-cap stocks ended in positive territory.

•  Bonds: Treasury yields fell. The 10-year Treasury yield closed at 4.07% and is now testing its 50-day moving average. Federal Reserve Chairman Powell stated that policymakers were close to being confident that the inflation downtrend would continue.

•  Gold: Gold rose 4.61% last week, showing steady growth since the March breakout without significant pullbacks. The SPDR Gold ETF (GLD) set record highs.

•  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 down last week. The S&P 500 decreased by 0.26%, the NASDAQ Composite was down 1.17%, the Dow Jones Industrial Average lost 0.93%, and the Russell 2000 small-capitalization index rose 0.30%. The 10-year Treasury bond yield fell 11 basis points to 4.07%, taking Treasury bonds higher for the week. Spot gold closed the week at $2,178.95, up 4.61%.

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 experienced a slight pullback last week but still set a new all-time high. The Index continues to trade well above its 200-day and 50-day moving averages. Since the October low, the market has faced minimal selling pressure. All pullbacks, including last week’s, have been short and shallow.

In recent weeks, markets have surged, with major indexes and many individual stocks reaching all-time highs. Last week’s price movements were largely driven by general consolidation activity. Mega-cap and semiconductor-related stocks, significant contributors to the market’s rise, saw some profit-taking activity. For example, the Vanguard Mega-Cap Growth ETF (MGK) dropped 1.5%, while the S&P 500 Index fell by just 0.26%. Meanwhile, the Invesco S&P 500 Equal Weight ETF (RSP) managed to gain 1.0% last week.

With markets rising based on future expectations of artificial intelligence (AI), Bespoke Investment Group analyzed market breadth during this rally to see if the small group of “AI stocks” was driving the gains or if broader market participation was contributing. Their findings revealed that while a select few stocks have significantly contributed to the upward momentum, overall market breadth has remained strong. The following chart of the cumulative advance-decline line for the S&P 500 suggests that breadth has closely tracked the Index’s move higher. Market practitioners use this type of analysis to confirm broad breadth in the movement of stock indexes.

Over the past decade, Federal Reserve policy has been fairly in line with other indexes of financial conditions. Bespoke created two financial conditions indexes, shown in the following chart. The index shown in light blue uses four inputs. The index shown in dark blue adds the level of fed funds rate into the financial conditions index. Although simple, these indexes illustrate how market-implied financial conditions, rather than those set by policymakers, are supporting the economy, even as Fed policy sits at restrictive levels. The strong performance of AI stocks and market momentum have helped narrow credit spreads, increase debt issuance, and generally accommodate economic activity.

The following chart shows that economic data has shifted from consistently exceeding expectations in the middle of last year to a more balanced performance in recent weeks. Markets have gotten accustomed to a resilient economy, but there are limits to how long a string of positive surprises can continue considering the current economic headwinds.

Around the globe, overbought conditions are pretty widespread. Bespoke Investment Group looked at global performance via its Global Macro Dashboard. Of the 22 country ETFs included in the dashboard, 15 are currently trading in overbought territory. More than half are in extreme overbought territory at more than two standard deviations above their 50-day moving averages. Of these widely extended ETFs, six are trading at new highs and many others are percentage points away from a new high. Brazil is the only region that is in oversold territory.

We recently added the Quantified Global Fund (QGBLX) to our Quantified Fund suite. The Fund offers potential international exposure within investment strategies where it’s appropriate. It applies dynamic risk management to baskets of global ADRs (American depositary receipts). These ADRs represent diverse technical, fundamental, and “market guru” factors. The Fund may adopt defensive positions, including holding cash, during market downturns.

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, 12.52%) to the SPDR S&P 500 ETF (SPY, 7.70%). 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 11 basis points last week, ending at 4.07%.

Last week, Federal Reserve Chairman Jerome Powell spoke before Congress. His testimony reiterated previous Fed talking points but offered less hawkish takeaways regarding the timing of future interest-rate cuts. Chairman Powell stated that policymakers were “not far” from being confident that the inflation downtrend would continue, a key condition for considering futures rate cuts. By the end of last week, futures markets were pricing in a slightly higher chance of rate cuts, with the CME FedWatch Tool registering a 71% chance of a cut at the Federal Reserve’s June policy meeting.

The 10-year Treasury pulled back to its 50-day moving average last week after trying to break higher in early February. With this pullback, traders are now watching for the formation of a bull price channel (if yields can exceed their mid-February peak). The slope of its 50-day moving average is still positive, while price action tests the 50-day moving average presently.

T. Rowe Price traders reported “another week of heavy issuance in the investment-grade corporate bond market, with USD 51 billion in total supply surpassing expectations of USD 30 billion to USD 35 billion. Technical conditions were supportive for high yield bonds, with coupon payments and tenders adding significant cash to the market, while net new issuance remained modest.”

Gold

Gold rose a whopping 4.61% last week and still hasn’t seen any pullback since the March breakout from its bear price channel (shaded region on the following chart). 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. The 50-day moving average is now sloping upward following the latest significant price move to the upside.

While media focus has been on the sharp rise in AI stocks and bitcoin, gold has also seen significant momentum. Last week, the SDPR Gold ETF (GLD) set new all-time highs, resulting in extremely elevated levels compared to its 50-day moving average. On Monday, the ETF closed 3.63 standard deviations above its 50-day moving average, marking its most overbought position since its launch. The last time it was over three standard deviations above its 50-day moving average was in March 2022.

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 70% long exposure. Exposure changed to 20% long at Tuesday’s close, 30% long at Wednesday’s close, and 0% at Thursday’s close. Our QFC Political Seasonality Index favored stocks 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 last week with 120% long exposure to the NASDAQ, changed to 140% long at Thursday’s close, and changed to 120% long exposure at Friday’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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