Market insights and analysis

By Tim Hanna

The major U.S. stock market indexes were up last week. The S&P 500 increased by 1.65%, the Dow Jones Industrial Average gained 0.38%, the NASDAQ Composite was up 3.04%, and the Russell 2000 small-capitalization index was up 1.89%. The 10-year Treasury bond yield rose 21 basis points to 3.67%, taking Treasury bonds lower for the week. Spot gold closed the week at $1,977.81, down 1.64%.

Stocks

Equity markets were up last week, with the S&P 500 hitting a new closing high of the year on Thursday, May 18. The outperformance of mega-cap stocks continued to drive indexes higher, as did an increase in the participation of lower-cap stocks. Investor optimism rose after President Joe Biden met with congressional leaders to discuss a debt ceiling deal on Tuesday. But negotiations stalled. Reporter Jake Sherman from Punchbowl News tweeted, “Debt limit talks between the White House and House Republicans have been paused, per multiple sources involved with the talks.” As a result, markets pulled back slightly on Friday, May 19.

On the economic data front, the NY Empire State Manufacturing Index, a survey of about 200 manufacturers in New York state that asks respondents to rate the relative level of general business conditions, came in at -31.8, much lower than the -3.7 forecast. Values above 0 indicate improving conditions, and those below 0 indicate worsening conditions. Retail sales were 0.4% month over month, below expectations of 0.8%. Unemployment claims came in at 242,000, while consensus expectations were for 253,000. The Philly Fed Manufacturing Index came in at -10.4, above expectations of -19.5. Existing home sales printed at 4.28 million, in line with expectations of 4.30 million.

Although the S&P 500 Index hit new yearly highs last week, it was unable to maintain price activity above 4,200 on a closing basis. 4,200 has been a major level of resistance since August of last year. The Index was able to increase the positive gap with its 50-day and 200-day moving averages. The majority of year-to-date price action has been above the 200-day moving average, and the golden cross (when the 50-day moving average crosses above the 200-day moving average) from late January remains in play. Market technicians consider price action above the 50-day and 200-day moving averages to be a bullish signal. A breakout above 4,200 could indicate a continuation of the trend to the upside over the intermediate term.

With earnings season now behind us, Bespoke Investment Group looked at reactions to the latest earnings reports from some of the largest S&P 500 stocks. This was a positive earnings season compared to expectations. Stocks that reported saw their share prices rise an average of 0.37% in response. Mega-cap stocks were the stars. The following chart shows the one-day change in response to earnings for the 20 largest stocks in the Index. The largest components, Apple (AAPL) and Microsoft (MSFT), rose more than 4% after reporting. The average one-day change for all 20 large-cap stocks was 2%.

Hundreds of companies report per day during the peak of earnings season, while only a few companies report each day in the offseason. The red line in the following chart shows the S&P 500 during earnings seasons since the beginning of 2022, and the blue line shows the Index during the earnings offseason. This season, earnings results and guidance were relatively strong. Each of the prior three earnings seasons saw markets rally, whereas this period resembled more of a sideways price structure (though the market did trade higher overall).

At the start of this year, investors saw a big shift in stock characteristics and factor performance compared to 2022. For example, stocks that were down the most last year were the biggest-gaining decile for the first month of this year, with an average return of almost 40%. Last year’s decile of biggest winners was down 0.3% in the first month of this year on average.

Bespoke calculated decile performance from March 10, 2023, (the day of the Silicon Valley Bank failure) through last week. Each stock characteristic in the matrix below is broken down by deciles of S&P 500 stocks (10 groups of 50 stocks each), and the average performance of the stocks in each decile since March 10 is shown. The matrix once again shows how well the largest stocks in the Index have done recently compared to the smallest stocks. It also highlights the significant underperformance of stocks with low price-earnings ratios, lower price-sales ratios, and high dividends. On the other hand, stocks with the highest valuations and no dividends have seen gains ranging from 6% to 10%.

Not only has the performance of stock characteristics shifted this year, but so have market patterns. The “buy the dip” trade (buying after a down day and shorting after an up day), an underperforming strategy last year, has returned in 2023. Another widely followed pattern gauge that investors track is the “after-hours trading versus regular session trading” metric. Historically, almost all of the stock market’s gains in the U.S. have come from after-hours trading (buying at a day’s close and then selling at the next day’s open). This hasn’t been the case so far in 2023. After-hours trading is down 2.3% year to date, while regular session trading (buying at a day’s open and selling at the close) is up 12.3% year to date.

As the performance of stock characteristics shifts and market patterns evolve, it’s important to incorporate dynamically risk-managed investment strategies that are able to respond to changing market conditions as the changes are reflected in asset prices.

For example, as markets have moved higher off lows set in the fourth quarter and experienced less downside volatility recently, many of our momentum-based strategies have moved into and are still in more risk-on positioning. If prices continue to move higher and experience low volatility, systematic trend-following algorithms are designed to recognize the price momentum and participate in a risk-on fashion. If volatility resurfaces and prices turn south, systematic momentum strategies are designed to identify the change and move to more defensive positioning. Mean-reversion strategies attempt to recognize and navigate sideways environments, offering an uncorrelated complement to momentum-based programs, which have more difficulty navigating periods that lack a trend.

The following chart shows the one-year performance of the Quantified Pattern Recognition Fund (QSPMX, 31.89%) compared to the SPDR S&P 500 ETF (SPY, 8.67%). Stocks have been in a sideways range since last year (yellow rectangle on the chart), and when and in which direction stocks will decide to move is uncertain. 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 and can be allocated to within our turnkey solution, QFC Fusion 2.0. Within our more customizable turnkey solution, QFC Multi-Strategy Core and Explore, QFC Multi-Strategy Explore: Special Equity is currently overweighted to QFC S&P Pattern Recognition.

Bonds

The yield on the 10-year Treasury rose 21 basis points, ending last week at 3.67%.

Last week investors digested hawkish-sounding commentary from Federal Reserve officials. Dallas Fed President Lorie Logan, a Federal Open Market Committee (FOMC) voter, stated that current data doesn’t yet support pausing interest-rate hikes in June. Her comments and others reinforced the notion that the Federal Reserve is not yet talking about rate cuts this year.

After struggling to trade above its 50-day moving average (green line on the following chart) since mid-March, the 10-year Treasury is attempting another breakout. However, it remains within its bearish price channel (black lines on the following chart).

T. Rowe Price traders reported, “The tax-exempt municipal bond market came under pressure as several new deals came to market, while a sale of tax-exempt holdings by the FDIC also increased supply.

“In the investment-grade corporate bond market, primary issuance was notably above weekly expectations, according to our traders—a new issue from Pfizer marked the fourth largest on record. Conversely, the high yield market saw somewhat low volumes throughout the week as investors digested debt ceiling headlines about positive momentum toward a deal while hawkish Fed commentary weighed on rates.”

Gold

Gold locked in a loss of 1.64% last week. The metal is still experiencing a mild pullback since its peak and 52-week high set in mid-April. After seeing little support at and now trading below its 50-day moving average, the next major level of technical support is at the 200-day moving average. However, with the magnitude of the rally since November, the 200-day moving average is still significantly below the current price action.

During gold’s recent pullback, investors have seen a very short-term rally in the U.S. dollar (the purple line in the following chart). The U.S. dollar and other non-equity or bond exposures are available asset classes for consideration within certain strategies at Flexible Plan Investments.

Flexible Plan Investments is the subadviser 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

The very short-term-oriented QFC S&P Pattern Recognition strategy started last week with 140% long exposure. Exposure changed to 130% long at Wednesday’s close, moved to 50% short at Thursday’s close, and remained there through the end of the week. Our QFC Political Seasonality Index favored stocks on Monday and Tuesday last week, moved to defensive positioning at Tuesday’s close, and then moved back to stocks at Thursday’s close. (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 100% long exposure to the NASDAQ. It changed to 120% long at Tuesday’s close and 140% long at Friday’s close. The Systematic Advantage (SA) strategy is 90% 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 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 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.