Market insights and analysis

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

3rd Quarter | 2020

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, Director of Research

The major stock market indexes were mixed last week. The NASDAQ was down 1.1%, the S&P 500 Index fell 0.5%, the Dow Jones Industrial Average fell 1.0%, and the Russell 2000 gained 0.4%. The 10-year Treasury bond yield rose about 10 basis points, as Treasury bonds fell slightly for the week. Last week, spot gold rose slightly, gaining 0.2%.

Stocks

The market continues to consolidate. Equity markets have remained relatively unchanged in October compared to September, which experienced losses. Once again, large-cap growth companies fell the most last week, while smaller companies gained. Over the past few weeks, we’ve seen quite a bit of this type of market rotation. This could indicate that losses among large caps are not heralding the type of volatility we saw earlier this year.

Another indication that markets are merely rotating rather than moving to safety is the performance of COVID-19-sensitive stocks. These stocks, which have benefited from demographic and consumer shifts in demand due to the pandemic, are not responding as well to upside earnings surprises as one might expect. The median response is actually negative, despite relatively strong earnings. This indicates that the bull run in these particular securities may be fizzling out as markets prepare for an end to pandemic behavior in consumers.

Earnings

A record number of companies are significantly beating earnings expectations this season. The same is true of revenues and earnings guidance, which are at multi-decade highs. This is partly because expectations earlier this year were so low due to the uncertainty about the pandemic’s impact on the global economy. However, second-quarter earnings offered examples of outperformance, so expectations for the third quarter should not be as affected by the pessimism of the first quarter.

Economic concerns going forward

Despite positive earnings news, some significant economic concerns still exist. COVID-19 cases are rising again in the U.S. as we enter the fall and winter seasons (although at less than half the rate of Europe), and U.S. unemployment is still high (although falling at a record pace).

The number of recorded COVID-19 cases in the U.S. is reaching the peaks that we saw in June–July, but the positive test rate is considerably below the levels we saw in the spring. However, it’s important to note that we’re testing more frequently than we did in those months, and we must remember that every positive test is counted on a per-test basis, not on a per-individual basis (leading to multiple tests being counted for the same patient). In addition, those infected tend to be skewing younger, so hospitalization and death rates are lower than they were in previous waves. While the number of cases is a cause for concern given how quickly they can ramp up, the demographic changes of those infected and the improvement in treatments make the overall outcome of this wave in the U.S. uncertain. And this uncertainty may lead to more volatility in the markets over the next few months as the situation evolves.

Another concern is U.S. unemployment, which remains at relatively high levels. Overall, the economy has bounced back strongly since the first quarter. However, the number of jobs lost during that period was so large that we’ve still not recovered. While more than half of the jobs lost during the pandemic have been restored in the last five months, it will take many more months to recover to pre-pandemic employment levels.

In addition, the estimate of the number of permanent job losses has increased to about 4 million this year, as more workers who were previously laid off or furloughed permanently lose their jobs. These job losses will be a significant economic headwind in the short to intermediate term.

Overall, while there are signs of strength, the U.S. economy will face challenges that may require further government intervention. Such intervention has become fairly common since the financial crisis. With the pandemic, it looks like it won’t be going anywhere soon.

Flexible Plan update

As the major asset classes were mixed for the week with no strong movements, our top-performing strategies were a mix of momentum-based, mean-reverting, and pattern-based strategies. Our Contrarian S&P Trading strategy performed the best, up by about 0.7%, followed by our Political Seasonality Index and Evolution Emerging Markets strategies, which were up by 0.6%.

Our worst performers were also of all different types this week. Our WP Aggressive strategy, while having a very strong year, was our laggard for the week, down by over 2%.

The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure remains at 196%.

Our intermediate-term tactical strategies are uniformly positive, although to various degrees. The Volatility Adjusted NASDAQ (VAN) strategy has a 120% exposure to the NASDAQ, the Systematic Advantage (SA) strategy is 138% exposed to the S&P 500, our Classic strategy is in a fully invested position, and our QFC Self-adjusting Trend Following (QSTF) strategy remains 200% invested. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Among the Flexible Plan Market Regime indicators, our Growth and Inflation measure continues to show that we are in a period of Stagflation (meaning a positive monthly change in the inflation rate and negative monthly GDP reading), though we do expect a reversion to a more normal market environment. In the current regime, gold tends to perform the best, followed by bonds, and then equities.

Our Volatility measure is showing a High and Falling reading, which favors gold over bonds and then equity, although all have positive returns in this regime stage.

Although our Political Seasonality Index (PSI) did well last week (and so far this week by being out of the market for the decline), it continues to be a choppy period for the PSI, as one would expect with the election quickly approaching. The methodology calls for a buy on October 29, followed by a sell on November 5, just after the election.

The uncertainty engendered by this election may be the greatest ever. Dr. Richard Peterson, who provides market media sentiment analysis on most financial markets, reports that his uncertainty measure is at its highest reading preceding a national election since he began collecting data in 2000. This provides a basis for the market currently moving strongly to the downside, but as in past election years, once the voters have spoken and removed the uncertainty, the present weakness can provide the basis for a surprising rebound into the year’s end.



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