Market insights and analysis

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 Jason Teed

Market snapshot

• Stocks: U.S. stock market indexes declined last week due to concerns over China's economic health and investors taking profits after recent market gains.

Gold: Spot gold prices fell alongside equities, losing 1.28%. This suggests the equity sell-off wasn't driven by investors seeking safe-haven assets or changing economic conditions, but rather market normalization.

• Bonds: In turn, U.S. Treasury yields mostly rose, especially for long-term bonds. This reflects market optimism about long-term economic growth despite the ongoing yield-curve inversion.

• FPI Market Regime indicators: Markets are in an Ideal economic environment stage (meaning inflation is falling and GDP is growing), which tends to favor stocks and bonds. Gold tends to underperform and experience higher risk in this environment. The S&P volatility regime is registering a Low and Rising reading, which favors gold over equities and then bonds.

• FPI strategy indicators: QFC S&P Pattern Recognition ended the week with slightly leveraged exposure. QFC Political Seasonality Index exited the market on Thursday’s (8/17) close. The Volatility Adjusted NASDAQ (VAN) strategy ended the week with a 200% exposure to equities. The Systematic Advantage (SA) strategy ended the week with a 30% exposure to equities. QFC Self-adjusting Trend Following (QSTF) began the week 200% long but changed to 100% long on Thursday’s close.Our Classic model was fully invested all week.

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The major U.S. stock market indexes continued their sell-off last week. The Russell 2000 small-capitalization index fell 3.41%, the NASDAQ Composite lost 2.59%, the Dow Jones Industrial Index was down 2.21%, and the S&P 500 dropped 2.11%.

The stock market's sell-off was fairly broad, though sector performance varied. Technology and Health care were the best-performing sectors, falling 0.82% and 1.57%, respectively. Consumer Discretionary performed the worst, falling 4.10% on reports of slowing sales from some retailers. There was no meaningful pattern in the risk-on and risk-off sector losses.

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

Many central banks around the world have been signaling a shift toward less-restrictive policies. Usually, markets respond positively to such a shift, seeing it as an indication of future tailwinds—or at least fewer headwinds. However, despite this typically favorable context, the S&P has declined in recent weeks. This may be due to investors cashing in on previous market profit, especially in the absence of significant news directing market movements.

For instance, the global impact of China’s softening economic markers is raising eyebrows. Historically, when one of the world’s major economies slows down, it has a ripple effect, dampening global growth and affecting inflation forecasts in bond markets.

But that’s not the case this time. Pessimism about China’s economic vitality has coincided with an uptick in U.S. Treasury yields, particularly at longer maturities. These long-term interest rates, which often reflect overall economic health and monetary policy trajectories, seem to be pricing in an economy resilient enough to tolerate steeper rates. Ten-year yields are at their peak since 2007, and the deeply inverted yield curve is beginning to normalize.

On another positive note, the latest earnings season has shed light on recent economic strength. A significant number of U.S. companies exceeded earnings estimates, resulting in a top-decile earnings-per-share (EPS) beat rate. However, revenue trajectories have been more subdued. This disparity highlights a trend of disinflationary pressures in both the U.S. and global economies. In short, companies have boosted earnings without increasing their revenue, mainly by cutting costs. With all of these dynamics in play, corporate guidance suggests investors have a reason to be optimistic.

Yet, despite the generally upbeat economic data, the market has given back some earlier gains, with small-cap stocks at the forefront. Earlier this year, small-cap stocks, which are more sensitive to the economic cycle than their larger-cap counterparts, performed well. They gained 14% from May to July, driven largely by hopes of an economic “soft landing.” However, they shed nearly half of those gains in August. Given the economic backdrop, this seems more like a market adjustment in line with realistic economic and valuation expectations rather than fear of a major decline.

This type of sell-off, resulting from a change in investment expectations rather than economic expectations, can also be seen in the reduction of the average price-earnings (P/E) ratio. Typically, when rates rise, the P/E ratio falls. However, we’ve seen a large gap between the two recently. This month’s sell-off doesn’t fully bridge that gap, but it does suggest that the market is merely normalizing.

While the recent market downturns might just be the market catching its breath, we’ll likely see more of this balancing in the upcoming months. With the stock market moving into what has historically been a two-month window of higher market volatility, the market might experience more turbulence compared to the earlier stability this year. As such fluctuations materialize and a path toward lower inflation and moderate economic growth emerges, active management will likely remain beneficial for investor portfolios.

Bonds

All Treasury yields except the one-month maturity rose last week. Longer maturities rose the most. Aggregate moves reduced the steepness of the yield-curve inversion, though it remains heavily inverted. Increases in longer-term rates suggest the markets are more optimistic about long-term economic growth.

Both term and credit yields increased last week, giving conflicting signals about bond market expectations of the economy. Overall, long-term Treasurys underperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

Gold

Spot gold fell for the week along with equities, losing 1.28%. This suggests that last week’s equity sell-off was not motivated by investors looking for a safe haven for their assets.

Historically, gold prices move inversely to real yields. Yet, despite the recent rise in the real yield curve, gold’s decline hasn’t been as sharp as traditional financial models might predict. Last week’s movement, though, aligned more with traditional economic thought. Thus, like equities, it may reflect a market that is transitioning back to normal rather than a shift in economic conditions.

Non-currency safe-haven assets, such as long-term Treasurys, were also down for the week.

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

Our Political Seasonality Index began last week fully invested, exiting the market on Thursday’s (8/17) 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 varied last week. It was largely leveraged for the week, reducing to 0.7X on Tuesday and to 0.3X on Thursday. It ended the week with slightly leveraged exposure.

Our intermediate-term tactical strategies are mixed in exposure. The Volatility Adjusted NASDAQ (VAN) strategy began last week 160% long. It changed to 200% long on Monday’s close, 180% on Tuesday’s close, and 200% on Friday’s close. The Systematic Advantage (SA) strategy was very active, trading nearly every day of the week. Exposures for Monday through Friday, respectively, were at 60%, 90%, 60%, 30%, and 30%. The strategy changed to 100% money market on Friday’s close. Our QFC Self-adjusting Trend Following (QSTF) began the week 200% long but changed to 100% long on Thursday’s close. 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 an Ideal economic environment stage (meaning a declining inflation rate and positive quarterly GDP reading). Historically, an Ideal environment has occurred 28% of the time since 2003 and has been a positive regime state for equities, and bonds, but negative for gold. Equities tend to outpace bonds on an annualized return basis in an Ideal environment, albeit with higher risk.

Our S&P volatility regime is registering a Low and Rising reading. This environment favors gold over equities and then bonds from an annualized return standpoint. The combination has occurred 27% of the time since 2003. It is a stage of moderate returns for equities and gold, and fairly low returns for bonds.



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