Market insights and analysis

By Jason Teed

Last week, major U.S. stock market indexes were mixed. The NASDAQ Composite Index gained 4.41%, the S&P 500 Index rose 1.43%, the Dow Jones Industrial Average fell 0.15%, and the Russell 2000 Index lost 2.64%.

Seven of the 11 market sectors gained for the week. Communication Services and Technology were the top-performing sectors, rising 6.94% and 5.66%, respectively. Continuing their declines from the previous week, Energy and Financials were the worst-performing sectors, falling 7.02% and 6.09%, respectively.

Stocks

The market is still digesting the news from the banking sector. No additional banks have failed, but some regional banks have experienced higher-than-expected withdrawals.

These banks have turned to the Federal Reserve’s emergency lending program, the purpose of which is to stop other banks from failing. So far, it has been successful on that point. Approximately $300 billion was lent in the last week, with about half of that being reserved for Signature Bank and Silicon Valley Bank. The Fed did not release the names of other banks.

Despite concern about the financial health of individual banks, the banking industry as a whole is in good shape—due primarily to the regulatory reform enacted since the 2008 financial crisis. For example, the Tier 1 capital ratio, an indicator of the strength of a bank’s balance sheet, remains extremely high by historical standards. The bank failures of the past couple of weeks were not due to overleveraged, speculative bets, like they were 15 years ago—rather, they were caused by bank runs.

That being said, dramatically raising interest rates is a stress on banks. In fact, the stress on the financial system itself may allow the Fed to pull back on rates more quickly.

Banks have been lending significantly less over the past few years, doing some of the Fed’s work themselves. And this trend will likely continue as banks become more cautious in the coming months.

Inflation can be tamed in several ways, all of which simply lead to lower demand in the aggregate. These ways include higher interest rates, tougher lending standards by banks and other institutions, and fear in the marketplace. Events of the past few weeks support the latter two.

The following chart shows the percentage of banks that have been tightening their standards, a practice that has increased dramatically in the past few months and is historically high.

What does this mean for the market going forward? The bond market appears to be pricing in an end to Fed tightening. The two-year government-bond rate has actually fallen below the fed funds target rate. This has always occurred around the same time that the Fed has stopped increasing rates. The market seems to believe either that (1) the Fed will not be able to raise interest rates further without putting too much stress on the financial system or (2) further hikes will not be necessary to tame inflation.

Considering the response to last week’s market movements by other securities affected by inflation, it would appear to be the latter. Commodities looked to follow bond rates down last week. This suggests that the market does not anticipate inflation to be a driving factor for commodities in the near future.

While the events of the last week or two have been dramatic, it doesn’t appear to have fundamentally shifted the strength of the economy or expectations of a recession going forward. In fact, the market seems to have become more optimistic. There will likely be stress going forward, and we may not have seen the last of the bank failures, but these events could signal the start of the end of interest-rate increases. If so, that could provide the stock market a bit of a reprieve after having been down over the past 15 months.

Bonds

Treasury yields mostly fell for the week. One-month and two-year maturities fell the most. This activity lessened the inversion of the yield curve. In addition, the two-year rate fell below the current fed funds rate. This typically happens just before the Fed stops increasing rates.

Both term and credit yields expanded last week, giving conflicting signals about bond-market expectations of the economy. Overall, long-term Treasurys outperformed high-yield bonds (though both were down significantly), and longer-term bonds underperformed shorter-term bonds.

Gold

Spot gold rose 6.48%, acting as a safe-haven security this week on tailwinds from falling bond rates.

The metal has enjoyed other recent tailwinds: Inflationary pressure seems to have subsided a bit, economic indicators suggest that the economy is slowing, and the stress being experienced in the banking sector could mean the Fed may not increase interest rates as much as previously expected.

Non-currency safe-haven assets, such as long-term Treasurys, were also up for the week, as longer-term rates fell for the period. Last week bucked the recent trend of higher-than-typical correlations between stocks, bonds, and gold, highlighting the significance of market stress we have experienced during the past couple of weeks.

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

The indicators

Our Political Seasonality Index began last week fully invested, exiting the markets on Thursday’s (3/16) close. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure began last week 0.7X long. It changed to 1.5X long on Tuesday’s close, 1.4X long on Wednesday’s close, and 0.7X long on Friday’s close. The strategy has been much more active lately than in the earlier parts of 2022.

Our intermediate-term tactical strategies are mixed in exposure. The Volatility Adjusted NASDAQ (VAN) strategy began last week 20% long, changing to neutral on Wednesday’s close. The Systematic Advantage (SA) was very active for the week. It began last week with a 30% exposure. It then changed each day, moving from 0% to 30% to 120%, before ending the week at 60%. Our QFC Self-adjusting Trend Following (QSTF) strategy began last week neutral to the market, changing to 1X long for the week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Our Classic strategy was fully invested for the week. The strategy can trade as frequently as weekly.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, currently indicates a Normal economic environment stage (meaning a positive monthly change in the inflation rate and positive quarterly GDP reading). Historically, a Normal environment has occurred 60% of the time since 2003 and has been a positive regime state for equities, gold, and bonds. Gold tends to outpace both stocks and bonds on an annualized return basis in a Normal environment, albeit with higher risk.

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 relatively low returns and higher volatility for the three major asset classes.