Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

3rd Quarter | 2021

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

By Jason Teed

The major U.S. stock market was mostly up last week, finishing a strong year. The S&P 500 rose 0.85% last week and was up 26% for the year. The Dow Jones Industrial Average gained 1.08% for the week and 18.73% for the year. The NASDAQ Composite fell 5 basis points for the week but finished up 21.39% for the year. The Russell 2000 gained 0.17% for the week and 13.70% for the year. The 10-year Treasury bond yield rose 2 basis points to 1.51% for the week, as bonds gave up some recent returns. At the beginning of 2021, rates were at 0.91%. Spot gold closed the week at $1,829.20, up 1.13% for the week. For the year, the metal was down 3.64%.

Ten out of 11 sectors were up last week. Real Estate and Utilities were the week’s best performers, up 3.69% and 2.64%, respectively. The Communications sector was the worst performer for the week, down 0.79%.

Stocks

2021 was a good year for the equity markets despite a lot of uncertainty. The S&P led the way, up about 26% in 2021—this after strong performances in 2019 and 2020.

Many factors led to this strong market performance, including consumer spending and the resulting growth in corporate earnings. Additionally, markets were flush with cash amid government fiscal support. This resulted in retail investors contributing strongly to the returns of individual stocks and some speculative asset classes, in addition to the market in general.

Consumer spending (charted above), dipped in 2020, but rebounded above 2019 levels by the beginning of 2021, increasing significantly in the first half of the year. Though spending declined later in 2021, it remained a strong contributor to economic growth.

Consumer spending growth was particularly pronounced in durable goods, likely due to purchases delayed by the pandemic. Nondurable goods came in second. Consumers favored physical purchases over services, which lagged.

These increases in consumer spending have led to a significant growth in corporate earnings year over year, which fueled further equity growth. Projected earnings growth in 2021 is 45%, which would put earnings well above pre-pandemic levels.

Markets also saw support from retail investors. With cash and time on hand, these investors became larger players in the market. Retail investors pushed GameStop and AMC Theatres stocks up 687% and 1,183%, respectively—much to the chagrin of institutional short sellers. The subreddit r/wallstreetbets also saw a huge influx of subscribers, representing the growing interest retail investors had in investing.

However, it’s likely that the peculiar circumstances of 2020 and 2021 led to this behavior, rather than market exuberance.

Going into 2022, the market still has many potential tailwinds, though we may not see the same returns we’ve seen in recent years. But before we talk about the positives, let’s first look at the challenges.

First, year-over-year comparisons will be more difficult. Compared to 2020, 2021 was a strong year. While earnings growth is expected to be positive in 2022, it will remain in a more typical range than we saw last year. Expectations are just below 10%.

Second, inflation continues to be a concern, and the expectation is that the Federal Reserve will increase interest rates to help control it. Increased rates tend to slow down economic activity by making it more expensive for both consumers and businesses to borrow. Most experts anticipate three interest rate hikes in 2022.

A third potential headwind is an expected increase in corporate taxes, including a possible 15% alternative minimum tax.

Lastly, quite a bit of economic uncertainty remains—and with it a lack of agreement on market performance in the coming year. While the consensus is that market index returns will be in the upper single digits, projections vary widely.

However, the market does have some factors going for it. COVID’s influence over the market seems to be receding. Despite significantly rising cases of the milder omicron variant, markets and consumer behavior have not meaningfully budged. This could be the first indication that the pandemic has moved into an endemic phase.

Supply-chain issues and labor shortages are also likely to subside in 2022, which will lead to further economic growth as businesses regain the ability to meet consumer demand. Companies have made large capital expenditures during the year to increase inventories, and these investments will further mitigate supply issues along various points in the chain. Major investments have also been made in shipping capacity, which should yield dividends later in the year. All of these suggest a more smoothly flowing economy and increased predictability for investors.

Additionally, the market setup going into this year is positive.

At the end of 2021, nearly all stocks in the S&P 500 Index were trading above their 10-day averages, and over 90% of them were over that level during the last week. This tends to be a good setup, with every past example leading to gains in the Index over the next six months.

Bonds

Treasury yields continued the upward trend they’ve had over the last year. This trend was particularly strong in December. The 10-year Treasury rose to 1.51%, though this was off from its recent October high of 1.70%.

Yields are still historically low, though rising overall. Term yields decreased last week and credit spreads increased. Both indicate a cautious view from bond investors. Overall, long-term Treasurys outperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

The yield curve shows a slight inversion from 20 to 30 years, but this may be due to liquidity issues in the 20-year offerings. Because these are newer offerings, they are not as popular with investors. Generally, the yield curve suggests a healthy economy going forward, with increases in interest rates likely in the near future.

Gold

Spot gold rose 1.13% last week, though it finished 2021 in the red. Other safe-haven assets, such as long-term Treasurys, were down for the week as rates increased. Increasing rates are often a headwind for gold, but not last week. The metal has been trading within a range for the last six months or so, but the outlook among investors seems positive.

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 more than nine years ago to track the daily price changes in the precious metal.

The indicators

Our Political Seasonality Index was fully invested last week and remained so to begin 2022. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure began the week 2X long, moved to 1.8X long on Tuesday’s close, and remained there for the rest of the week.

Our intermediate-term tactical strategies are uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy began the week 20% exposed, changed to 40% exposed on Monday’s close, and changed to 60% long on Friday’s close to begin the new year. The Systematic Advantage (SA) strategy began the week 90% exposed to the market, changed to 120% exposed on Thursday’s close, and remained there for the rest of the week. Our QFC Self-adjusting Trend Following (QSTF) strategy began the week 160% exposed, changed to 200% exposed on Thursday’s close, and remained there for the rest of the week. 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, shows that we remain in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and positive monthly GDP reading). Historically, a Normal environment has occurred 60% of the time since 2003 and has been a positive regime state for stocks, bonds, and gold. Gold tends to outpace both stocks and bonds on an annualized return basis in a Normal environment but also carries a substantial risk of a downturn in this stage. From a risk-adjusted perspective, Normal 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 equity over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2000. It is a stage of lower returns and higher volatility for all three major asset classes.



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