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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 Jerry Wagner

The major market indexes finished mostly down last week. The Dow Jones Industrial Average lost 1.11%, the S&P 500 Index fell 0.29%, the Russell 2000 small-capitalization index slid 1.08%, and the NASDAQ Composite climbed 0.40%. The 10-year Treasury bond yield rose 0.02 basis points to 3.46%. Gold futures closed the week at $2,018, down $6.80 per ounce, or 0.34%.

Stocks

 

Stocks continued to move sideways last week as they have throughout 2023. The S&P 500 Index took a shot at a new high but failed to surpass the high made back in February. The only index showing much strength has been the NASDAQ 100, which hit a new post-crash high, propelled by artificial intelligence plays and the big five tech stocks.

The twin demons of the financial markets at the moment are the fight over the debt ceiling and the next Federal Reserve policy decision. This week, the former takes precedence, reversing last week’s ranking in the headlines of the financial press.

The president says the U.S. Treasury will default and run out of cash by June 8.

Congressional Republicans say that uncontrolled spending (yielding an annual deficit of $1 trillion) is causing the national debt (now 120% of the entire national GDP) to grow to the point where it threatens national security.

The charts suggest that both sides may be right, but the nation and the financial markets are held in the balance if a compromise cannot be reached. The Republicans may currently hold the higher ground, but only because they have already passed a bill raising the debt ceiling, albeit with uniform department spending cuts that are not palatable to the administration.

Unfortunately, the Senate has not taken up the bill, nor is the president likely to sign such a bill if it were to pass. A compromise between these disparate political factions—something we have not seen much of in the last couple of decades—is necessary to solve this matter.

Matters seem a bit better in the halls of the Federal Reserve, where the possibility of a pause in the campaign to defeat inflation has been waged by relentlessly raising interest rates. The Fed would like to take us to the very edge of a recession and then walk the economy back without experiencing one. Some believe that the Fed may have finally seen the light and recognized that we may already be in a recession and will call for a pause in its hikes at its next meeting in June.

If it does, market history suggests that a new high in stocks should be right around the next corner. However, given the prevailing high expectations of a pause, a resumption in hikes could send stocks still lower.

Despite the focus on these two matters in the financial press, other matters of note may affect the future direction of stock prices.

Several signs indicate that a recession may already have taken hold. Among the latest are a substantially inverted yield curve and a retail sales report that fell short of predictions, coming in at only +0.4% when double that was anticipated. The Federal Reserve Bank of New York now puts the probability of a recession in the next 12 months at 68%. That’s the highest monthly reading since 1983.

At the same time, the current sideways market has seen a dramatic reduction in volatility as measured by the degree of the swings in daily stock prices. Historically, this tends to occur more often before rallies than before declines. Similarly, when more than 50% of sub-industry groups exhibit positive momentum over the previous year after falling to a historically low level, good things tend to happen to stocks. Since 1942, the S&P 500 has never been lower a year later.

Generally, earnings have been stronger than expected this earnings season—and our nation’s CEOs have been on average raising guidance for the future.

Bullish sentiment among average investors, on the other hand, has plunged. While the bears now outnumber their more positive brethren.

Bottom line: The markets are being held hostage by the headlines. While technical and historical precedents suggest stocks should move higher from here, there is a significant event risk that could send the market back to test its October lows before that high is reached. In some ways, it’s like the end of 2008 when we saw a nice rally only to see new lows in March 2009.

Yet look at the market gains since either point in time. You could not be called wrong for buying in a little early at the end of ‘08.

Bonds

Just a week after registering a death-cross chart pattern (when the 50-day moving average, or MA, of the 10-day yield fell below its 200-day MA), which should have sent yields falling, yields are now suddenly rising. They have now breached the 50-day MA, and a move up to the 200-day-MA line can be expected.

Rising yields have caused longer-term bond prices to fall in search of support. The failure to resolve the debt-limit crisis discussed above will continue to put pressure on bonds, although a clear signal of a pause would send yields lower and bonds higher. Once again, we seem to be held hostage by these issues.

The high-yield sector of the bond market has stalled with the stock market. It has held above support and remains near its recent highs, but we could be in for a retest of the March lows before those highs are surpassed.

Gold

Gold has been in a rally since the first of November. It has spent two months above its 50-day moving average. But it has been weak in May so far, and its position above that moving average is threatened.

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.

While gold appears ready to break below its moving average, the dollar has already 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 bullish, as are the midterm indicators. The short-term-oriented QFC S&P Pattern Recognition strategy has moved to 140% exposed to the S&P 500 Index, an index that it is handily besting so far in 2023.

Our QFC Political Seasonality Index (PSI) strategy had been fully invested but sold on Tuesday’s (5/16/23) close. Thereafter, the PSI embarks on a very choppy period as it buys back in on May 18, then sells again on May 24, and then returns to equities on May 26.

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 120% invested, the Systematic Advantage (SA) strategy is 60% in equities, and our QFC Self-Adjusting Trend Following (QSTF) strategy is positioned 200% 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.



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