Market insights and analysis

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

2nd 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 indexes ended higher for the week. The Russell 2000 small-cap index gained 2.45%, the NASDAQ Composite gained 2.08%, the S&P 500 was up 1.20%, and the Dow Jones Industrial Average gained 1.03%. The 10-year Treasury bond yield fell 3 basis points to 1.59%, taking bonds slightly higher for the week. Spot gold closed at $1,903.77, up 1.20%.

Four sectors were down last week, though not significantly. Communications and Consumer Discretionary were the best performers last week as consumer demand continues to aid these sectors. Utilities was the worst performer.

Stocks

The equity markets were up last week. The riskiest components of the market were up the most. Both cyclical and small-cap companies outperformed larger-capitalization and more defensive stocks. Overall, some segments of the equity markets appear frothy, though fundamentals and confidence are improving globally.

Inflation appears to be a concern, at least in the short term. This environment tends to benefit productive assets like stocks whose underlying revenue and profits should, theoretically, also grow with inflation.

Stocks appear to be overbought in the near term. But as the economy continues to recover, company fundamentals may be able to catch up with higher-than-typical market valuations. One prominent example is the trading of “meme” stocks such as GameStop and AMC. Retail investors have bid up these companies, which are some of the most heavily shorted in the market. The result is that the companies’ stock prices have completely decoupled from their underlying fundamentals.

This decoupling of price and fundamentals has persisted, subjecting holders of those stocks to an unusual type of risk. These companies could revert to fundamentals-based pricing at any point. For GameStop, this averaged around $11 at the beginning of the year. Analysts have since increased the average target price to $55, which would represent a loss of over 70% to any investor at today’s market price.

This does seem to suggest a certain amount of frothiness in the markets, as individuals are willing to plow money into investments of which they are not well-informed with little concern for the downside risk. This type of investor behavior is typical in asset bubbles.

However, overall, economic conditions appear to be improving both domestically and globally. For the majority of 2021, the U.S. has outpaced the rest of the world in terms of both COVID vaccinations and economic growth. But the rest of the world is beginning to catch up. Many positive sentiment indicators confirm this.

The eurozone, which has had a particularly difficult time with variants and vaccine rollout logistics, appears to be recovering in terms of investor sentiment.

Inflation also suggests that economic conditions are beginning to normalize. While inflation has increased sharply year over year, there are a few things to keep in mind: 1. Inflation during 2020 was depressed, so the comparisons to the previous year will seem dramatic. 2. Several specific industries are contributing an outsized increase to the aggregate inflation reading due to COVID-related supply-chain issues (such as the semiconductor chip shortage). 3. Leisure and business industries heavily affected by the pandemic (such as car rentals and airlines) are beginning to normalize.

Considering the source and type of inflation that we’re currently seeing, it’s unlikely that the Federal Reserve will take any steps to attempt to lower inflation in the near future since it expects increased inflation to improve on its own.

In total, it appears that while some segments of the market are experiencing bubble-like behavior, that behavior is not yet widespread. Equity valuations, while elevated, may be supported by corporate fundamentals resulting in aggregate economic growth.

Bonds

Treasury yields decreased once again, as yields continue to ease. The 10-year Treasury fell 3 basis points last week to 1.59%.

Yields are still historically low. They had been rapidly increasing this year, but have taken a breather, coming off recent highs. Credit spreads fell for the week and term spreads decreased, both indicating an increased demand for bonds overall. Generally, long-term Treasurys outperformed high-yield bonds, and longer-term bonds outperformed shorter-term bonds.

Expectations for the intermediate term are for interest rates to remain relatively low, leading investors to seek yield in other places. This will likely lead investors to bid up the price of high yields and compress the credit spread as the economy continues to recover.

Gold

Last week, spot gold closed at $1,903.77, up 1.20%. Other safe-haven assets, such as long-term Treasurys, outperformed, primarily due to a pause in increasing interest rates. As interest rates decrease, gold becomes more attractive than bonds, which creates buying pressure on the metal. Though inflation appears to be rebounding, the nature of that rebound is likely to keep the Fed standing pat on interest rates at this time.

Flexible Plan is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction almost nine years ago to track the daily price changes in the precious metal.

The indicators

Our Political Seasonality Index started last week out of the market but entered on Tuesday’s (May 25) close. It exited again on Thursday’s (May 27) close. (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 was 2X long for the week.

Our intermediate-term tactical strategies are uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy started the week with 40% exposure to the NASDAQ. It increased exposure to 60% on May 25 and to 100% on May 27, remaining there to begin this week. The Systematic Advantage (SA) strategy was 90% exposed to the market last week, changing to 120% exposure to begin this week. Our Classic strategy is in a fully invested position. Our QFC Self-adjusting Trend Following (QSTF) strategy started the week 80% long, changed to 100% long on Monday, changed to 200% long on Thursday, and remained there to begin this 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, 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 equities 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 average returns for equities and gold, but lower-than-average returns for bonds.



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