Market insights and analysis

By Jerry Wagner

Market snapshot

• U.S. market indexes had mixed performance last week. The S&P 500 and NASDAQ rose, but the Russell 2000 lost value. Bonds rallied, and gold futures increased by 1.29%.

• The market focused on negative news such as high interest rates and weakness in the Chinese economy, overlooking positive earnings and housing stats. Fedspeak from Jackson Hole indicated a possible final rate increase in November.

• Despite concerns about the yield inversion predicting a recession in early 2024, it is still considered a good time to increase exposure to the equity markets.

• September is historically the worst month for stock market returns, but in pre-election years when year-to-date returns exceed 10% by the end of August, the outlook for September and the rest of the year tends to be positive.

• Market regime indicators show the market is in an Ideal economic environment stage, which is historically positive for stocks and bonds but with a substantial risk of downturn for gold. Volatility is High and Rising, which has been positive for all asset classes but with the greatest risk for stocks.

The major U.S. stock market indexes finished mixed last week. The S&P 500 Stock Index rose 0.80%, the NASDAQ rallied 2.26%, and the Russell 2000 lost 0.31%. Bonds rallied after the sharp sell-offs of the previous week. The U.S. Aggregate Bond ETF (AGG) posted a gain of 0.3%, and the 20-year Treasury Bond ETF (TLT) rallied 1.55%. Gold futures closed the week at $1,941.30, up $24.80 per ounce, or 1.29%.

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Stocks

Long-term uptrends (200-day moving averages) and golden crosses (when the short-term moving average crosses above its long-term moving average) remain in place for the S&P 500 Stock Index (SPX) and NASDAQ. However, since the S&P closed at a new high at the end of July, stocks sold off close to 10% by their mid-August lows. Since then, the bulls have tried to move the market higher with some success, although small caps continue to lag.

The stock market has been focusing more on negative news this month. Reports of high interest rates, weakness in the Chinese economy, and mixed economic indicators have overshadowed headlines about recent expectation-beating earnings and revenues and last week’s better-than-predicted housing stats.

Most of the recent attention has centered on the Federal Reserve news from the Jackson Hole Economic Policy Symposium. While last year’s meeting brought some shock and awe to the markets, this year’s get-together seemed to be a ho-hum event. Interest rates spiked a bit after Fed Chairman Powell’s remarks, yet by day’s end, they had returned to the same level as before he spoke. Most market seers continue to believe that rates will likely hold steady at the next meeting, with perhaps a better chance of a final rate increase in November.

If there is one final rate increase in the near future, the historical implications for stocks are very good. As the following chart shows, stocks have always outperformed commodities and bonds over the next year and also over most three- and five-year periods.

We have been talking about yield inversion (short-term Treasury bills yielding more than their longer-term counterparts) for almost two years—because that condition so accurately predicts the coming of a recession. The most-watched inverted yield measure is the three-month T-bill versus the 10-year bond.

This yield measure approached zero in early 2022 and topped the 1% mark in 2023, suggesting a recession in early 2024. After the move in 2000, I believe we first dipped into a recession that summer. However, the normal period between the inversion and the onset of recession is over 500 days. So far, we are at about the 300-trading-day level—far from the average. Based on this indicator, a recession would begin, on average, around next May.

One can also see from the above chart that we seem to have peaked this summer. In other words, the inversion is no longer getting worse. If this is indeed the top, then that tells us what to expect between now and the recession’s beginning next spring, should one occur as predicted.

As the previous chart illustrates, in at least two instances, with actual recession lead times for each signal that are near the long-term average, the S&P’s path leading up to the recession was solidly bullish. Even in cases where the actual lead time was shorter than average, the S&P’s performance was flat with no substantial downside. This suggests that for investors concerned about a recession, now is still a good time to increase your exposure to the equity markets.

Finally, many investors have heard that September is the worst month for stock market returns, so this time of year can cause some apprehension. As the following chart shows, when calculating the average returns for all days in the year, there is a decline or flat period in September. Yet, if you look at September’s performance in pre-election years, the majority of the days are positive and the month is profitable.

Furthermore, when examining historical data for Septembers in which the year-to-date returns exceed 10% by the end of August (as will be the case this year), the outlook for September and the rest of 2023 looks rosy. The S&P’s average performance in such instances has far exceeded that of an average year.

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

Bonds

Yields on the 10-year Treasury bond hit a new high for this bond bear market. Yields on all shorter-term Treasury bills and bonds hit their high-water marks, as well. According to SentimenTrader’s historical records, this has led to even higher rates in the immediate future. It has also signaled flat or lower short-term returns for stocks.

The higher yields have meant that the long government bond ETF (TLT) has been under considerable pressure, almost returning to its October 2020 bear market lows. It tumbled along with most everything else in August, even exceeding the decline in the S&P 500. It is more than two standard deviations from its average performance. If we were talking stocks, we would expect a mean-reversion bounce here, but bond history suggests that the rally in yields will continue and TLT will maintain its decline.

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 more in line with stocks than bonds.

Gold

Gold declined less than stocks and long-term bonds in August. While it has not moved above its 50-day moving average, it has made progress in the last week—despite higher real yields for bonds and a rising U.S. dollar. The latter seems to have leveled off in the last week or so, which is supportive.

I am concerned that the weakness in the Chinese economy will spill over into the gold market. China is facing some deflationary pressures, and weakness there could easily spread to its Southeast Asian neighbors and India. This could result in less holiday and end-of-the-year spending in these countries, which has been a significant contribution in recent years. What has also been helpful is the aggressive gold acquisition by the central banks of the expanded BRICS coalition, which increased its number of members from five to 11.

Most market gurus expect weakness in gold until 2024. Seasonal studies also highlight this weakness in historical charts.

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 bearish. Still, the QFC S&P Pattern Recognition strategy has stayed at 50% exposure to the S&P 500 Index.

Our QFC Political Seasonality Index (PSI) strategy has been out of the market since August 24 and will buy back into stocks on August 30. Thereafter, the PSI will move to a sell on September 5 and remain out of stocks for the rest of the month.

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 140% 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 100% 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 High and Rising reading, which favors equities over gold, and then bonds from an annualized return standpoint. All have had positive returns in this environment, although stocks have experienced significant downside risk. The combination has occurred 23% of the time since 2003.