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 were mostly up for the week. The Russell 2000 gained 2.16%, the NASDAQ Composite rose 1.85%, the S&P 500 (which continues to hit new highs) was up 0.41%, and the Dow Jones Industrial Average fell 0.80%. The 10-year Treasury bond yield dropped 10 basis points to 1.45%, taking Treasury bonds up for the week. Spot gold closed at $1,877.53, down 0.74%.

Six out of 11 sectors were up for the week. Real Estate and Health Care made the largest gains. Materials and Financials were the worst performers for the week, with inflation concerns depressing the latter.

Stocks

The riskiest components of the market were up the most last week. Both cyclical and small-cap companies outperformed larger-capitalization and more defensive stocks. U.S. housing and construction costs hit record levels.

Inflation has been a concern, as it has the power to affect the economy in the intermediate to long term. Thinking regarding inflation seems to fall into two camps at the moment.

Many, including the Federal Reserve, are taking the stance that inflation is not a major concern. Inflation is high relative to 2020 when the economy was tanking due to pandemic lockdowns. Supply chain issues beyond the initial disruptions last year continue to exist. Both of these factors are expected to be temporary.

Others, such as Deutsche Bank, believe that the U.S. government’s pandemic-related spending was overly aggressive in its support of the economy. Their concern is that this risks runaway inflation that would require significant economic disruption to bring under control.

While it may be prudent to keep an eye on inflation, as the previous chart shows, the consumer price index (CPI) has reached this level before without leading to runaway inflation.

It also makes sense to look at the market segments that are contributing the most to the gains in the CPI. Quite a few industries that were severely disrupted by the pandemic last year are major contributors to inflation this year: Rental cars, leisure activities such as restaurants, sporting events, and groceries were all major contributors. All had major supply chain or demand disruptions last year and are still normalizing.

If the CPI continues to rise and other market segments begin to contribute to these gains, even as COVID-affected industries normalize, then inflation may become a larger concern for markets.

Stocks that had rebounded from a depressed 2020 low are now off their recent yearly highs. This suggests that valuations have already been reached and the stock market may be done correcting for those companies’ stock movements over the last year.

Additionally, tech stocks, which were favored during lockdown, had seen some selling pressure as the economy began to reopen last year. Now, these stocks are once again moving up. This movement is unlikely to be related to COVID specifically since hospitalizations, cases, and infection rates are all down from historical levels and vaccination numbers in the U.S. continue to increase.

It makes sense that these stocks would do well even in a post-COVID environment. More people have moved to working from home permanently, and many companies are embracing hybrid in-office/remote working models.

These sectors appear to be normalizing somewhat. However, sector and stock rotation will likely continue to be a significant source for potential investment gains. Many industries and sectors continue to face disruption as much of the world is unvaccinated and COVID continues to disrupt global supply chains. The U.S. may be isolated to a certain degree from these threats, at least in overall equity market movement, but it may nevertheless create an opportunity for active investors.

Bonds

Yields are still historically low. They had been rapidly increasing this year, but they have been declining slowly since their peak at the end of March. Credit spreads fell slightly for the week and term spreads increased, indicating expectations of a healthy economy going forward. Overall, long-term Treasurys outperformed high-yield bonds, and longer-term bonds outperformed shorter-term bonds.

Expectations for intermediate-term government bonds 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

Typically, gold tends to outperform when interest rates fall. However, concerns about inflation may be easing, making gold less attractive than bonds. This is because gold is typically a hedge to inflation, and interest rates often increase as inflation rises. These price movements seem to indicate that, at least for the time being, the markets are less concerned with inflation than in previous weeks.

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 fully invested in the equity markets. It sold out on Monday’s (June 7) close, bought back in on Wednesday’s close, sold once again on Friday’s close, and started this week out of the market. (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 started last week 2X long, dropped to 1.8X long on Thursday, and remained there to begin this week.

Our intermediate-term tactical strategies are uniformly positive, although to varying degrees. The Volatility Adjusted NASDAQ (VAN) strategy started the week with 120% exposure to the NASDAQ. It increased exposure to 160% on Wednesday and to 140% on Friday’s close to start this week. The Systematic Advantage (SA) strategy was 90% exposed to the market last week. Our Classic strategy is in a fully invested position, and our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long for the 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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