By Tim Hanna The major U.S. stock market indexes were down last week. The S&P 500 decreased by 2.41%, the Dow Jones Industrial Average lost 2.14%, the NASDAQ Composite was down 2.80%, and the Russell 2000 small-capitalization index gave back 2.55%. The 10-year Treasury bond yield fell 21 basis points to 2.92%, taking Treasury bonds higher for the week. Spot gold closed the week at $1,811.79, down 3.82%. Stocks Equity markets finished the week down on concerns over growth, elevated volatility, and downward momentum. Weakening technical factors also contributed to the poor performance, even with Friday’s pop in markets. The Federal Reserve is expected to continue its aggressive tightening plans in its efforts to fight rising inflation. In global news, Finland and Sweden have announced that they are seeking to join NATO to ensure their national security against Russia in the future. Reuters reports, “President Vladimir Putin said on Monday that there was no threat to Russia if Sweden and Finland joined NATO but cautioned that Moscow would respond if the U.S.-led alliance bolstered military infrastructure in the new Nordic members.” In the U.S., the Senate confirmed Federal Reserve Chairman Jerome Powell for a second term, Lisa Cook was confirmed to the Federal Reserve Board, and Lorie Logan was named Dallas Fed president (effective August 22). On the economic data front, the consumer price index (CPI) came in at 0.3% month over month (m/m), slightly above expectations of 0.2%. Core CPI (m/m) was 0.6%, above the 0.4% that was expected. The producer price index (PPI) was in line with expectations at 0.5% (m/m). Core PPI (m/m) was 0.4%, lower than the 0.6% forecast. Unemployment claims reached 203,000, slightly worse than the expected 190,000. Import prices (m/m) came in at 0.0%, lower than the 0.6% forecast. The University of Michigan’s preliminary consumer sentiment declined 9.4% from its level the previous month to 59.1, below the 64.1 that was expected. The S&P 500 made a big leg down as prices failed to hold support at yearly swing lows. The “death cross” (when the 50-day moving average crosses below the 200-day moving average) from mid-March remains in play as price has formed a bearish channel year to date. The S&P 500 almost entered bear market territory last week. As markets continue their move down, so has sentiment. Bespoke Investment Group reported that their composite index of investor sentiment dropped to its lowest level since February 2016, with a net bullish sentiment reading just above 35%. Since 2006, there have only been a few other weeks when sentiment was as low or lower than it is now. The current level ranks below the second percentile relative to all prior weekly readings. The following table shows each week when sentiment ranked in the second percentile or below since the start of the composite index. Most readings occurred in bunches within a year, with the last one occurring in February 2016. Generally, forward one-month returns were positive with a median gain of 3.73%, and gains followed all but three of the readings. Interestingly, three-month returns were negative following all of the 2008 occurrences but have been positive since then. Six-month and one-year returns were negative for the first few occurrences in 2008, but positive for the remainder. As is the case during periods of volatility, large intraday swings and directional indecision are more commonplace. What is noteworthy of late is that the volatility index (VIX) has not surged significantly, but intraday volatility has been extreme. Over the trading day on Wednesday, there were 10 separate 1% swings in the NASDAQ, including three different declines of more than 2%. The team notes that this kind of volatility in a single day only occurs during periods of extreme market stress. Investment and market research firm SentimenTrader points out that there has been a big spike in 52-week lows on the New York Stock Exchange (NYSE) and NASDAQ exchanges. More than half of S&P 500 stocks are in bear market territory. Falling stocks and credit are causing financial conditions to tighten quickly as fundamentals are also deteriorating. Given this, it’s no surprise that sentiment is very low among investors. The team studied the forward performance of the S&P 500 after NYSE 52-week lows as a percentage of issues traded crossed above 30%. Over the past 85 years, the study generated a signal 23 other times. The Index closed higher one week later for 17 consecutive signals since 1962. The study shows a drop in performance six months following the signal. Sentiment indicators have historically been more contrarian indicators, so a retracement in a longer-term bear channel could be possible. The following chart shows that “smart money/dumb money” confidence is tied for its fourth-lowest level since 1998. While stock prices have tumbled this year, as-reported earnings haven’t yet. Price usually leads earnings, so earnings will likely start to decline. The combination of declining prices and steady earnings has caused the S&P 500 price-earnings (P/E) ratio to decline significantly. While the S&P 500 has pulled back almost 20% from its peak, its valuation metric has declined almost twice that to over 35%. When the S&P 500’s P/E ratio was more than 35% from its peak, the Index has had an annualized return of 19.6%, mostly due to large and persistent rebounds following protracted sell-offs. The following table shows future period returns once its valuation dropped by more than 35% from a multi-year high. Future performance periods are generally positive, but, as can be seen, some of the signals occur midcycle. With so much uncertainty across markets and the globe, active, risk-managed strategies that are able to respond to changing market conditions are more important than ever. With sentiment (a historically contrarian signal) at record lows, it’s critical to respond to price movements as they come, rather than trying to predict them based on news and emotions. If prices continue to go down and volatility remains elevated, systematic momentum strategies will remain defensive. However, if a new uptrend emerges this year, systematic trend-following algorithms will recognize the price momentum and reduced volatility, stepping back into the “risk-on” camp. The following chart shows the year-to-date performance of the Quantified Managed Income Fund (QBDSX, +0.0%) compared to the iShares Core US Aggregate Bond ETF (AGG, -9.8%). The Quantified Managed Income Fund is an actively managed income fund that can seek various income classes as well as the safety of cash when market exposure is undesirable. The Fund is a key defensive component in several actively managed strategies at Flexible Plan Investments. Bonds The yield on the 10-year Treasury fell 21 basis points, ending last week at 2.92% as the bond market saw some relief. Last week showed signs that the historical inverse correlation between stocks and bonds may be returning to some degree. Year to date, bonds have struggled to deliver the protection investors expect as equities go down. With the 10-year Treasury peaking at 3.15% the previous week, most of the price action last week was under the 3.0% level. T. Rowe Price traders reported, “… Corporate credit spreads widened over the week alongside moves lower in the equity market and broader risk-off sentiment. Against the weaker macro backdrop, primary issuance was relatively subdued, with the weekly total falling short of expectations. Weakness in the high yield market reflected the pullback in equities, and credits from companies that missed earnings and/or revised guidance lower were notable underperformers. The primary market was quiet as most issuers remained on the sidelines amid the heightened volatility.” Gold Last week, gold fell 3.82%, ending the week testing the trend-line breakout from early February (see the black line in the following chart). The move last week retraced the remainder of the gains from the origination of the move as the 200-day provided little support for the yellow metal. Although gold fell significantly last week, geopolitical tensions, inflation fears, recession fears, and Fed rate hikes continue to make a fundamental case for gold into 2022. Just as the historical stock and bond relationship hasn’t been there for investors this year until last week, gold’s run may regain steam, especially if we see some weakening in the U.S. dollar over the coming months. The purple line in the following chart shows how strong the move in the U.S. dollar has been, with the correlation to gold being negative since late April. 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 The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure started last week with 80% long exposure, changed to 160% long at Monday’s close, changed to 120% long at Wednesday’s close, and changed to 80% long at Thursday’s close. Our QFC Political Seasonality Index favored defensive positioning throughout last week. (Our QFC Political Seasonality Index is available—with all of the daily signals—post-login in our Weekly Performance Report section under the Quantified Fund Credit category.) Our intermediate-term tactical strategies have been varied in their degree of defensive positioning. 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 was 60% short (negative) the NASDAQ throughout last week. The Systematic Advantage (SA) strategy is 60% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 0% exposed throughout last week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%. Our Classic model remained out of stocks last week. Most of our Classic accounts follow a signal that will allow the strategy to change exposure in as little as a week. A few accounts are on platforms that are more restrictive and can take up to one month to generate a new signal. Our strategies mostly remain relatively underexposed to the market, having exited several weeks ago. Volatility remains high, and the overall market direction appears to be downward. Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators , shows that we continue to be in the Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative quarterly GDP reading). This environment has occurred only 9% of the time since 2003 and favors gold and bonds, while equities tend to fall. Gold tends to significantly outpace both stocks and bonds on an annualized return basis in this environment, with a lower risk of drawdown than equities. From a risk-adjusted perspective, Stagflation is one of the best stages for gold. 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.