Market insights and analysis

By Jerry C. Wagner

The major market indexes finished up last week. The S&P 500 Stock Index rose 1.0%, the NASDAQ rallied 2.0%, and the Russell 2000 gained 1.1%. Bonds struggled. The U.S. Aggregate Bond ETF (AGG) posted a loss of 0.4%, and the 20-year Treasury Bond ETF (TLT) dropped 1.9%. Gold futures closed the week at $1,967.70, down $7.60 per ounce, or 0.38%.

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

Long-term uptrends for the S&P 500 Stock Index (SPX) and NASDAQ remain in place. SPX closed at a new 2023 high on Friday (July 28). In addition, the Index is within 5% of its all-time high, set back at the beginning of 2022.

In the past, a bounce back to within 5% of a previous high (coming at least 200 days after a pullback began) has led to a higher value for the Index 90% of the time over the next week, and 1-year median gains of 15% (with 80% profitable trades), according to SentimenTrader research into stock market behavior since 1950.

We seem to be in a period in which investors are trying to grapple with a new reality. While fears of recession are still being bandied about with plenty of rational justifications, the reality that is slowly appearing does not seem to fit the well-argued recession models advanced for the last year and a half. A better fit was last summer’s economic swoon, which was forecast by the decline in stock prices and rise in yields (especially of the Fed-assisted short-term variety) that marked the first half of 2022.

Now we have to deal with a financial world where the Federal Reserve is nearer to the end of its tightening phase than the beginning, inflation that is slowing rather than expanding, and an economic landscape that ambiguously includes both a slowdown in manufacturing and services and an expanding labor force and GDP.

Investors often hear the refrain, “The stock market looks ahead six months into the future,” yet they rarely invest that way. Instead, investors are more often prone to recency bias and base their actions on the recent past seen in their rear-view mirrors, rather than on what they see through their windshield on the highway ahead.

How else can we interpret today’s financial warriors leaping headlong into the trenches of money-market and fixed-term-rate annuities? They seem to be merely fighting last year’s battles, overlooking or possibly unaware of the very real opportunity costs—a trap that has ensnared past investors who have fallen victim to the same temptations at similar stages of the economic cycle. As our recent white paper “The hidden cost of fleeing from equities to CDs and fixed-rate annuities” shows, such behavior with even a $100,000 account can lead to millions of dollars of foregone growth. (This white paper is for financial professionals only. A summary of its results for the general public is available here.)

Last week’s GDP and inflation reports bear witness to the new reality, but are investors taking heed? GDP growth in the second quarter was up by 2.4%—more than the previous quarter’s 2% annualized growth rate and easily besting economists’ woeful 1.7% average forecast. At the same time, the rate of inflation demonstrated by the Fed’s preferred Personal Consumer Expenditure (PCE) measure showed inflation virtually cut in half from its rate just a year ago. While it’s difficult to argue that even this rate is low enough (especially given the cumulative nature of inflation), its downward cascade cannot be denied.

Still, all the latest data contains its own contradictions that seemingly “keep hope alive” among the stock market bears and the recession believers. Buried in the GDP reports were signs of a slowdown in consumer spending. And while the GDP report supported the cooling inflation data, that information and the falling rents on apartments seemed incongruous with a still strong existing housing market and a resurgence in higher oil prices.

Economic and fundamental data seem to always contain these sorts of conflicts. It’s the reason, I believe, so many investors throw up their hands and walk away from investing, shaking their heads at what appears to be the irrationality of it all.

It’s the very reason why when I first entered into the study of the financial markets over 50 years ago that I quickly learned to focus instead on indicators of human behavior hidden in plain view in market price history. Today the message of countless indicators emerging from this data is almost uniformly the same: While a short-term stumble can happen at any time, I have rarely seen a period when more of the indicators have been broadcasting such a consistently positive message—that is, it is likely that stock prices will be substantially higher six months to a year from now.

For example, SentimenTrader reported this week that, obviously unbeknownst to those investors rushing into money markets and fixed annuities, the S&P 500 (and the NASDAQ, for that matter) have been up five months in a row. Similarly, in the last three months, a “trifecta” of ever-higher gains occurred each month for the period ending July 31 this year. The firm wondered what happened when these events occurred in the past.

The answer: upside momentum continued. In fact, SentimenTrader showed that better than 95% of the time, the S&P 500 was broadly higher nine months later. It wasn’t perfect, but if one had invested every time that that set of circumstances had occurred since 1950 and held for the next nine months, the chart of that investor’s investment history would have looked like this:

A very pretty picture, indeed—and very different from the confusing one many investors see today when looking at the markets through a purely fundamental or economic lens. More important than this single set of signs is the fact that it is just one of scores of indicators that have been sending the same message since late last year. And the chorus of measures in agreement just grew in number with the stock market breakout in May.

Even before then, all of our intermediate-term tactical strategies had been fully invested, and often fully leveraged, to take advantage of the new market reality. This year’s real-time buy and sell signals for all of these strategies is available here (for financial professionals only).

Returning to the market update, it should be noted that we are in earnings season. So far, nearly half of the companies within the S&P 500 have reported, and over 160 of the S&P 500 companies are set to release their second-quarter numbers. A stumble by one of the mega firms or a collection of missteps by firms in a prominent sector or two can always contradict history and the story being told from the past. This week, the most prominent reports will be Apple’s and Amazon’s second-quarter missives coming after Thursday’s close.

So far, earnings season has been relatively benign. While revenue reports have been soft, with only 58% beating analyst forecasts, over 70% of earnings reports have outperformed. These are lower numbers than what we have been experiencing but still substantially better than average readings over time.

Volatility continues at a historically low rate, as further discussed at the end of this update. On the sentiment front, metrics such as consumer confidence have been rising. We’ve reached the point where stories of overconfidence are increasingly common.

Further, there is no doubt that stocks are overbought in relative terms. The S&P 500 and Russell 2000 are registering readings not seen since last year—and in some cases, not since 2020.

Yet contrary to conventional wisdom, historic data suggests that the positive momentum evidenced by these readings is likely to continue, particularly when viewed against the backdrop of a recent bear market low.

Bottom line: While we may see some short-term weakness in stocks, the prospects for the intermediate- and long-term remain very strong.

Bonds

Yields on the 10-year bond have trended higher since they crossed above their 50-day moving average in May. This happened despite the increasingly common belief that the Fed is nearing a pause in its war on inflation. Although the rise in yields itself paused as July began, the recent crossing of the 50-day moving average of yields over its 200-day moving average seems to indicate a resurgence in yields. They are now approaching their 2022 high-water mark.

This rising yield environment has sent bond prices lower across the board over July. Still, Treasury bond prices at the long end of the yield curve have been in a sideways channel for most of the year, as both stocks and bonds seem to have bottomed at the same time last October.

The high-yield sector of the bond market remains above its moving average. Although other types of bonds have been down and yields up, high-yield bonds have been following their stock market underpinnings and moving higher. The new yearly highs suggested in my last update have come to pass, and more are likely to be in the wings in the intermediate-to-long term if the prognostications in the Stocks section of this update occur.

Gold

Gold, unlike bonds, rose in value in July. It is up nearly 8% year to date and is back above its 50-day moving average. Most of the gains came as the U.S. dollar fell drastically in the first part of the month, and many central banks around the globe added substantially to their gold reserves.

Still, when the U.S. GDP report came in higher than anticipated last week, it immediately sent the dollar up on expectations that the Fed still had room to raise rates higher. The price of gold immediately fell in response to the dollar’s improved prospects.

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 10 years ago to track the daily price changes in the precious metal.

The indicators

The very short-term technical indicators for stocks that I watch are all bullish. Still, the QFC S&P Pattern Recognition strategy has moved to a negative 50% contrarian exposure to the S&P 500 Index.

Our QFC Political Seasonality Index (PSI) strategy had been fully invested since July 25 and will sell on August 17. Thereafter, the PSI will be in a very choppy period with almost weekly switches in position until September 5 when a longer-term sell signal will be initiated.

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 remain invested. Classic continues 100% long equities. The Volatility Adjusted NASDAQ (VAN) strategy is 160% exposed to the NASDAQ 100, the Systematic Advantage (SA) strategy is 90% in equities, and our QFC Self-adjusting Trend Following (QSTF) strategy is positioned 200% in the NASDAQ 100. 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 markets are in an Ideal economic environment stage (meaning inflation is falling and GDP is growing). Historically, an Ideal environment has occurred 28% of the time since 2003 and has been a positive regime state for stocks and bonds. Gold tends to underperform both stocks and bonds on an annualized return basis in an Ideal environment and carries a substantial risk of a downturn in this stage. From a risk-adjusted perspective, Ideal is one of the best stages for stocks, with limited downside.

Our S&P Volatility regime is registering a Low and Falling reading, which favors equities over gold, and then bonds from an annualized return standpoint. All have had positive returns in this environment, although gold has experienced significant downside risk. The combination has occurred 37% of the time since 2000.