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 Tim Hanna

Major U.S. stock market indexes were up last week. The S&P 500 increased by 2.00%, the Dow Jones Industrial Average was up 1.42%, the NASDAQ Composite gained 3.05%, and the Russell 2000 small-capitalization index was up 6.09%. The 10-year Treasury bond yield fell 10 basis points to 1.45%, taking Treasury bonds higher for the week. Spot gold closed at $1,818.36, up 1.96%.

Stocks

Each of the major indexes set record highs last week. The Russell 2000 small-capitalization index was the leader, tripling the return of the S&P 500 for the week. The last time small-cap stocks had this large of a weekly gain was back in March of this year. The Russell 2000 broke out of its year-to-date sideways range and joined the other major indexes in the breakout to new value zones.

Aside from momentum pushing markets to new highs, fundamental factors helped support gains. The Federal Reserve left the federal funds rate unchanged on Wednesday and reiterated that it is in no rush to raise rates as the Federal Open Market Committee announced that tapering asset purchases by $15 billion will begin this month. Interest rates dropped last week amid tempered rate-hike and inflation expectations. Chairman Powell stated inflation should be less of an issue by the second or third quarter of next year.

On the economic data front, nonfarm employment change was stronger than expected, coming in at 531,000 compared to the anticipated 400,000. Unemployment claims were at 269,000, compared to the 273,000 expected. The unemployment rate came in at 4.6% versus the forecast of 4.7%. Average hourly earnings (month over month) came in at the expected 0.4%. ISM Manufacturing PMI was 60.8 versus expectations of 60.4, and ISM Services PMI registered 66.7 compared to the expected 61.9.

Against the background of the Fed’s taper announcement and continued global supply-chain issues, Bespoke Investment Group released research focused on energy, capital expenditures, labor, and inflation in the fourth quarter. The following key findings from the research could be relevant to investors preparing to make year-end investment decisions and formulate their outlooks for 2022.

Earnings continue to rise rapidly. Amid low real rates, next 12-month EPS (earnings per share) forecasts are expected to top pre-COVID peaks by 25%. The 10-year TIPS (Treasury Inflation-Protected Securities) yield remains 90 basis points below where it was when earnings last peaked. Much higher earnings power combined with much lower real discount rates is a perfect recipe for huge market gains, according to Bespoke. The firm notes that the path may be rocky. The increase in inflation and improvement of labor markets make Fed rates hikes in 2022 and a higher real yield term structure more likely.

Over recent weeks, indexes have set record after record. The S&P 500 is on a streak of seven straight record highs through last Friday (November 5). This is one of the longest post-WWII streaks. Bespoke identified 10 other streaks of seven or more consecutive record closes. Once the streak ends, the S&P 500 has continued to outperform the norm over the next year. Across all occurrences, one-year performance was positive every time.

From a longer-term technical perspective, performance outlook leans in the positive camp, considering uniformity in new highs and breakouts between indexes. From a short-term perspective, U.S. equities are registering overbought readings relative to their trading ranges. Analysis of historical prices suggests that equities may be due for a pullback as they march to uncharted territory long term. Other than DIA and IWR (both still overbought), all of the ETFs that Bespoke considers in its relative-strength trend analysis are registering extreme overbought readings.

Pullbacks come in different degrees, speeds, and intensities. Only time will tell whether markets will experience more short-term volatility before moving higher as most investors expect. There is also no certainty that markets will move higher, especially if what investors think is a pullback turns into a correction. Incorporating active, risk-managed strategies can help manage downside risk in periods when market volatility is prolonged, with certain strategies being able to profit as markets are in an established downtrend.

Bonds

The yield on the 10-year Treasury fell 10 basis points to 1.45%, placing it right at the support line of the uptrend that started in August. The Federal Reserve’s signal that it plans to take a patient approach toward tightening monetary policy, coupled with tempered inflation expectations, helped push the yield lower.

T. Rowe Price traders reported, “The Fed meeting boosted sentiment toward investment-grade corporates, leading to spread tightening later in the week. A similar dynamic played out in the high yield bond market, where the firm’s traders noted that the well-telegraphed tapering announcement from the central bank prompted investors to add risk in high yield.”

Gold

Last week, gold climbed 1.96%, once again trading at the upper bound of the trading range that started in late June. The yellow metal experienced resistance at both the 50-day and 200-day moving averages over recent months, with prior breaks above failing. Currently sitting in a similar pattern, gold pierced through both downtrending moving averages and a recent swing high. Buying at support levels during the pullback will help guide whether there is any potential for sustained strength behind this breakout attempt.

Flexible Plan Investments is the subadviser 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 very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure was 80% short to start the week, changed to 20% short on Tuesday’s close, changed to 10% short on Wednesday’s close, and changed to neutral on Friday’s close. Our QFC Political Seasonality Index favored stocks last week and traded into a defensive position on Friday’s close. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Quantified Fund Credit category.)

Our intermediate-term tactical strategies are positive, although to varying degrees. The key advantages these strategies offer to investors is their ability to adapt to changing market environments, participate during uptrends, and adjust exposure to more defensive posturing during downtrends.

The Volatility Adjusted NASDAQ (VAN) strategy started last week 160% long to the NASDAQ, changed to 180% on Monday’s close, changed to 160% long on Thursday’s close, and changed to 200% long on Friday’s close. The Systematic Advantage (SA) strategy is 120% exposed to the S&P 500, and our Classic model is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long throughout last week. 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 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 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 Low and Falling reading, which favors stocks over gold and then bonds from an annualized return standpoint. Historically, stocks have experienced the lowest maximum drawdown while in this regime relative to the other volatility regimes. The combination has occurred 37% of the time since 2003.



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