Market insights and analysis

By Jerry Wagner

Market snapshot

•  Stocks: Major indexes finished down last week, with the S&P 500 falling through its 50-day moving average. Volatility increased, and adverse economic reports (including rising unemployment) contributed to market declines.

•  Bonds: Bond prices rallied, with yields falling significantly. Economic reports suggesting potential weakness ahead drove the market rally. The 10-year Treasury yield dropped 40 basis points to 3.8%.

•  Gold: Gold prices climbed 2.10% to $2,478.80 per ounce. Gold has been in a six-month rally to new highs, benefiting from a weakening U.S. dollar and falling bond yields.

•  Indicators: Short-term technical indicators for stocks are bearish. FPI’s intermediate-term tactical equity strategies show mixed signals. The market regime is classified as “Normal” (with inflation and GDP growing), while the S&P volatility regime is registering as “High and Rising.”

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Most major stock market indexes finished down last week. The Dow Jones Industrial Average fell 2.1%, the S&P 500 Index also slipped 2.1%, and the NASDAQ Composite shaved 3.3% off its value. The Russell 2000 small-capitalization index tumbled 6.7%.

Bonds and gold provided an almost perfect counterweight to stock losses last week. The U.S. Aggregate Bond ETF (AGG) climbed 2.4%, and the 20-year Treasury Bond ETF (TLT) shot up 6.0%. The 10-year Treasury bond yield fell 40 basis points to 3.8%. Gold futures closed at $2,478.80, up $50.90 per ounce, or 2.10%. The U.S. trade-weighted dollar lost 1.1%.

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

The S&P 500, the world’s most benchmarked index, slashed through its 50-day moving average last week like a laser beam cutting through the fog. The Dow lost more than 1,000 points on Friday and Monday, and volatility soared as the VIX (fear) index rose at a rate not seen since the early days of COVID-19. The tech-heavy NASDAQ entered correction territory, declining more than 10% from its recent high.

The stock market started last week on a positive note and was on the upside by Wednesday. Following the Federal Reserve report and Chairman Powell’s press conference, the market rose further.

The Fed report used language identical to its past reports to hold the line on interest rates. However, as Bespoke Investment Group related:

But Chair Powell’s press conference after the statement was much more dovish than the unchanged statement. Chair Powell emphasized repeatedly that the committee was very comfortable moving towards cuts near-term: a rate cut “could be on the table at the September meeting,” “the reduction of the policy could be as soon as September,” “base case [is] that policy rates would move down from here.” He not only refused to push back against market pricing, but he directly validated it. Recent labor market data was seen as “normalization” and Powell cited the Employment Cost Index report (discussed later) as evidence of an economy that has “normalized.”

There was plenty of evidence of the chairman’s “normalization” last week if that’s what you call a weakening economy. Ultimately, the cumulative negative weight of these reports dampened the stock market’s sense of euphoria. Here are some examples: 

•  The June Job Openings and Labor Turnover Survey (JOLTS) report from the Bureau of Labor Statistics (BLS) described an economy with declining job openings, new hires, a lower quit rate, and falling wages and salaries. The one positive was declining labor costs, but of course, that was due to the previously mentioned reductions in compensation.

•  Then the July Institute for Supply Management (ISM) manufacturing report showed that new orders, employment, and prices were all down. Only delivery time was rising, and who wants that to happen?

•  The coup de grâce was the BLS employment report on Friday morning. Expectations were for no change in the key statistics. But, while job growth came in weaker but still positive, unemployment jumped from 4.1% to an estimated 4.3%. Although there was an effort to blame the rise on the decline in temporary workers due to Hurricane Beryl, the market was not buying it.

To make matters worse, the jump in the rate triggered the Sahm rule, a benchmark created by former Fed economist Claudia Sahm. She found that since the 1950s, a 0.5% rise in the unemployment rate over its 12-month average rate has been an almost perfect predictor of a recession in the United States.

While some market researchers argue that past instances of the rule occurred in different economic settings (payrolls decreasing, not rising; yields rising, not falling; and real consumer spending declining, not growing), the stock market was not looking for rationalizations. It was overbought, and plenty of other bad news supported bringing the word “recession” back into the conversation.

As always, other economic stories last week did not fit the narrative moving the market. Before the employment report, the Atlanta Federal Reserve’s GDPNow indicator still signaled 2.5% GDP growth for the U.S. economy, and earnings reports were positive.

By August 1, 985 companies had filed their second-quarter earnings reports, with a better-than-average 71.5% outperforming analysts’ predictions. However, revenue results could have been better, with a mediocre 61.5% beating expectations.

Finally, recent signs indicated overseas markets were starting to outperform their U.S. counterparts. But those hopes were dashed by the recent market decline, suggesting that something else may be afoot besides the U.S. economic situation. The Japanese economy and its stock market have been especially worrisome. After leading stocks higher for most of the year, an unexpected move by the Bank of Japan to raise interest rates sent Japanese stocks into a tailspin. The news also strengthened the Japanese yen and weakened the U.S. dollar, decimating a hedge fund favorite, the yen/dollar carry trade.

Bottom line: The market continues to be news-driven, and plenty of news exists to drive it. Volatility will likely stay high in the short term, especially with negative seasonality and a unique presidential election on the horizon.

Bonds

Despite 2023 ending with a solid rally, 2024 had been a volatile year for bonds, with little overall progress. For most of the year, bond indexes have been in negative territory year to date. But since hitting a low point in April, bonds have been rallying. Last week, they reached a new high, sending interest rates tumbling on the back of multiple economic reports that suggest tough times ahead for the economy.

Two-year government bond yields have fallen over 100 basis points since May. Because these yields most closely signal the level of the fed funds rate 12 months ahead of time, this is positive news. Similarly, the yields on the 10-year bond fell almost 40 basis points last week, the most significant decline in that yield rate since the global financial crisis. As a result, mortgage rates are already improving.

As bond yields have fallen, bond prices have soared. Since April, the long-term government bond ETF (TLT) price has been in a strong uptrend.

Like much of the stock market, the high-yield sector of the bond market has recently stalled. The high-yield ETF (HYG) reached a new rally high as recently as the Friday before last. Although high-yield bonds tumbled with stocks last week, falling rates moderated their decline, which also helped all other bond categories.

Gold

Gold has been rallying to new highs for six months, making it overbought on many short-term and even intermediate-term measures.

The prospect of falling yields usually makes the U.S. dollar less attractive than other currencies. This is especially true now against the rising yen, which was bolstered by the Bank of Japan’s decision to raise rates contrary to other central banks. The same inverse relationship applies to the dollar’s value versus gold. As the dollar falls, gold seems more attractive. With the dollar returning to its March lows, gold has rallied strongly.

Gold is above its 50-day moving average, which usually provides short-term technical support for the yellow metal’s price.

Flexible Plan Investments (FPI) serves as the subadvisor for the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX). Introduced 11 years ago, the fund is designed to track the daily price changes in gold more tax-efficiently than its ETF counterpart, GLD.

The indicators

The very short-term technical indicators of future stock market price changes I watch are bearish. However, some oversold short-term patterns suggest that the remainder of the week could be positive. The QFC S&P Pattern Recognition strategy currently has a 40% exposure to the S&P 500 Index.

Our QFC Political Seasonality Index (PSI) strategy has been in the stock market since July 23. Although it showed weakness for the August 2-6 period, it was not enough to move us to the sidelines. With the next sale set for August 26, the indicator will avoid stocks until September 16. Our QFC Political Seasonality Index strategy is available separately and included in our QFC Multi-Strategy Explore: Special Equities and QFC Multi-Strategy Portfolio strategies. (The PSI calendar—with all of the 2024 daily signals—can be found post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.)

FPI’s intermediate-term tactical equity strategies are mixed. Classic continues 100% long equities. The Volatility Adjusted NASDAQ (VAN) strategy is just 40% exposed to the NASDAQ 100, while the Systematic Advantage (SA) strategy is 90% in equities. Our QFC Self-Adjusting Trend Following (QSTF) strategy moved to 1.6X exposure on July 17, 2024. It then moved to 0.8X on July 25 and to 100% cash on August 4. VAN, SA, and QSTF can all employ leverage—hence, the investment positions may sometimes be more than 100%.

FPI’s Growth and Inflation measure, one of our Market Regime Indicators, shows that markets are in a Normal economic environment stage (inflation and GDP are growing).

Historically, a Normal environment has occurred 60% of the time since 2003. In a Normal climate, gold outperforms stocks and bonds on an annualized return basis, but it also carries the most downside risk. From a risk-adjusted perspective, Normal is one of the best stages for bonds, followed by gold and then stocks.

Our S&P volatility regime is registering a High and Rising reading. This environment sees positive returns for all asset classes but at below-average levels. Still, it favors equities over gold and then bonds from an annualized return standpoint. Volatility, of course, favors bonds; gold and stocks have had a high maximum drawdown during these periods (over 30%). Equities have the higher of the two but carry a better risk-adjusted return. The High and Rising combination has occurred 23% of the time since 2003.