Market insights and analysis

By Will Hubbard

The major U.S. stock indexes were mostly down last week. The S&P 500 Index decreased by 0.80%, the Dow Jones Industrial Average lost 1.24%, the NASDAQ Composite gained 0.07%, and the Russell 2000 small-capitalization index lost 0.51%. The 10-year Treasury bond yield moved up 1 basis point to 3.44%. Spot gold closed the week at $2,016.79, up 1.35%.

Stocks

Equity market returns were mixed last week following a slew of economic data leading up to the interest-rate announcement from the Federal Open Market Committee (FOMC). Daily market action generally followed suit.

The market got off to a rocky start last week due to worse-than-expected economic data before seeing a nearly 2% gain in equities on Friday (May 5).

On Monday, the ISM Manufacturing PMI report showed the sixth-straight month of contraction for U.S. factory activity. The number came in at 47.1, slightly better than expectations of 46.8. The current contraction is the longest stretch since 2009, indicating ongoing unease in the manufacturing sector.

Tuesday’s JOLTS (Job Openings and Labor Turnover Survey) number came in at 9.59 million, less than the expected 9.74 million. JOLTS represents the number of job openings in a month, excluding the farming industry. While a reduction in job openings may signal economic concern for some, the Federal Reserve could view it as a welcome leading indicator that inflation may have peaked. Part of the Fed’s issue containing inflation is that increasing rates has done very little to curtail demand. An increase in unemployment could provide meaningful reduction in demand, which would help drive inflation closer to the Fed’s 2% target.

The FOMC released its statement on interest rates Wednesday afternoon (May 3). The results are in line with the forecasted federal funds rate being 5.25% and the actual being a 0.25% increase to 5.25%. Year-over-year inflation rates are coming down and are now at levels seen before the global financial crisis. Many experts believe we are at the top of the rate-hiking cycle and that fed funds rates will begin to subside later this year after a few “pauses.”

Notably, Chairman Powell’s statement contained language that seeks to justify the Federal Reserve’s decision to remain hawkish. Changes to one of the sentences telegraphed the Fed’s interest in pausing rate hikes while retaining the right to move them higher: “In determining the extent to which additional policy firming may be to return inflation to 2 percent over time.”

The statement suggested that the rate increases have helped with inflation but that the job market is still strong. Should we see continued strength and elevated inflation, Chair Powell was keen to remark that there may be further rate hikes even if the door for a pause is left open. As of today, the market does not seem to be pricing this information in.

Following the Wednesday announcement, the market rallied. The NASDAQ ended the week higher, gaining over 2% from its May 4 low. The S&P 500 and Dow Jones Industrial Average posted losses despite the rally.

On Friday, the unemployment rate came in at 3.4%, lower than the expected 3.6%. If the trend continues and inflation remains elevated, the position of some experts that there will be “no more interest-rate increases” is likely to be challenged.

Bonds

The 10-year Treasury was relatively flat before the Federal Reserve announcement on Wednesday. For the week, yields moved up 1 basis point to 3.44%.

Last week’s FOMC announcement may have been anticipated by the market, but some of the information in Fed Chairman Powell’s statement was not. None of the FOMC voters dissented. Powell said, “People did talk about pausing but not so much at this meeting.”

As we see in the employment data (both JOLTS and the unemployment rate), the job market remains strong, and demand for workers is strong. Powell described the demand for labor as still too high. Demand for workers drives wages higher, which corresponds to inflation that is more difficult to manage. The Fed is keenly aware of this based on its tepid language, which leaves room to continue hiking rates if appropriate.

Despite that, the market continues to price in rate cuts toward the end of the year, according to Bespoke Investment Group. Powell, however, is direct in his messaging: “It would not be appropriate to cut rates; we won’t cut rates.” The increasingly negative green bars in the following chart show how the market is more aggressively pricing in end-of-the-year rate hikes.

Gold

After rising 1.35% last week, gold is still just off all-time highs. The yellow metal is up nearly 10% year to date, while the U.S. dollar struggles. The dollar is mostly flat for the year, returning -1.6%. For those keeping score, we’ve been emphasizing gold’s inverse correlation with the U.S. dollar over the last few years. That correlation continues to hold as the dollar struggles and gold advances.

Flexible Plan Investments (FPI) 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 60% short. On Monday’s close, it moved to 110% short. On Tuesday’s close, it reduced exposure to 50% short. On Thursday’s close, it reversed course to 160% long. On Friday’s close, it realized some gains and moved to 120%. Our QFC Political Seasonality Index started the week positioned in its 100% equity, risk-on mode. On Friday’s close, it switched to its defensive positioning. (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 was 40% long all week. The Systematic Advantage (SA) strategy started the week 120% long and slowly reduced exposure throughout the week. On Monday’s close, it decreased exposure to 90% long. On Tuesday, exposure was further reduced to 60% long. On Wednesday, it made its final exposure reduction to 30% long, where it remained the rest of the week. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long 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 in a long, risk-on position all 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.

FPI’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.

The S&P volatility regime is registering a High and Falling reading, which favors gold over bonds and then stocks from an annualized return standpoint. The combination has occurred 13% of the time since 2003. It is a stage of higher returns and lower volatility for bonds relative to the other volatility regimes.