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.

Market Update 9/14/20

The major indexes posted losses last week. The NASDAQ finished the week down 4.60%, the S&P 500 lost 2.51%, the Dow Jones Industrial Average was down 1.66%, and the Russell 2000 small-capitalization index lost 2.48%. The 10-year Treasury bond yield fell 5 basis point to 0.67%, as Treasury bonds rose for the week. Last week, spot gold closed at $1,940.55, up 0.34%.

Stocks

Equities declined for the second week in a row. Technology stocks have led the markets higher over the past few months; however, last week they experienced their worst performance since the beginning of the pandemic sell-off in March. With markets testing new highs recently, it’s uncertain whether there is enough momentum to push through, maintain highs, and use those levels as future support. Bespoke Investment Group’s research report “Momentum Matters Most,” published Friday (9/11), reiterated the importance of momentum required at these critical levels.

According to Bespoke,

“US equity markets have retreated rapidly out of overbought territory as the S&P 500 tested its 50-DMA to close the week. The chart for the S&P is still barely holding onto its uptrend off of the March lows, and while the index broke below its 50-DMA intraday on Friday for the first time since April, longs were able to push it higher late in the day to close above the 50-day. This was the 98th straight trading day of closes above this key technical moving average. The Russell 2000’s chart is much more ominous, with the recent breakdown clearly busting support after a clean double-top. Tech, growth, and momentum stocks, proxied by the Nasdaq 100, have had a brutal run out of overbought territory of late and made new lows for the current selling cycle below the 50-DMA today. Broken momentum in this segment of the market is of far greater concern because of how far the stocks had run in their most recent advance.”

It’s interesting to note that much of the sell-off occurred above the medium-term moving average, as represented by the 50-DMA. Bespoke discovered that this is relatively unusual historically. They continued their research by looking at the S&P 500’s 10 worst declines above the 50-DMA. The team noted,

“The 6.8% drop over five days through Thursday’s closing low for the S&P 500 left the index above its medium-term moving average, and that makes one of just a handful of instances where large declines came while still closing above the 50-DMA. As shown in the table below, declines of more than 6% in that scenario haven’t been seen since the depression; only 1988 makes for a top 10 entry with the rest dating to pre-World War 2. Forward returns aren’t as bad as they could be, but are still negative over the subsequent 3, 6, and 12 months.”

Bonds

Regarding the fixed-income markets last week, T. Rowe Price reports,

“The yield on the benchmark 10-year Treasury note ended modestly lower for the week, pulled down in part by the news of the pause in the AstraZeneca trials. The broad municipal bond market was little changed through most of the week. The firm’s traders reported solid demand for new issues but also noted that investors in the secondary market took a more cautious approach. Muni bond funds experienced roughly USD 1 billion in net cash flows for the week ended September 9, according to Lipper data, marking the 18th straight week of positive flows. The investment-grade corporate bond primary calendar was very active, and the volume of issuance exceeded expectations. Most new deals were well received, partly due to stronger demand from investors in Asia. Strained U.S.-China relations and some negative Brexit headlines at times contributed to risk-off sentiment, however.”

Gold

Gold, after setting highs in early August, has been trading within a descending-triangle pattern since then. Last week, the metal was up 0.34%, with spot gold closing at $1,940.55.

From a purely textbook technical standpoint, such price patterns are considered to have a bearish bias. However, experience with technical patterns over time leads practitioners to quickly realize it’s more important to study the price action during such patterns rather than predicting and hoping for an action. To highlight this concept, the green and red arrows on the previous chart represent the expectation on price during a breakout in each direction out of the triangle pattern. Simply put, if gold breaks out of the upper descending trend line, the expectation is that the price will continue to go up. If prices break below horizontal support, the expectation would be for prices to go down and use that level as resistance.

At Flexible Plan Investments, we don’t try to predict what the market is going to do. Instead, we react to what the market is signaling to us when making trading decisions. As an example, some of our systematic algorithms attempt to recognize price action in securities, like those described above, to determine risk-on/risk-off positioning. If the price breaks down below the triangle, the algorithm would recognize the increase in risk and attempt to make adjustments in order to protect investor capital.

Analyst Leigh Drogen supports this thesis, stating,

“In the realm of technical analysis we normally think of the descending triangle pattern as being bearish. But if you believe taking a glance at the chart and labeling those squiggly lines ‘descending triangle’ and playing for a bearish break is going to make you money, you’re missing the point. As you all know, technical analysis isn’t necessarily about the pattern itself, it’s about the psychology of what’s going on within the pattern. As well, when bearish patterns fail, they can produce extremely quick and powerful bullish moves.”

The indicators

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, shows that we remain in a Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative monthly GDP reading). Historically, Stagflation has been a positive regime state for gold, which tends to outpace both stocks and bonds during such an environment. Although this environment does not occur often historically, it will be interesting to see if it can help gold continue its uptrend and break out to the upside from its current descending-triangle price pattern.

Our Volatility composite (gold, bond, and stock market) maintains its High and Rising reading, which favors stocks over gold and then bonds. Notably, all three asset classes have positive returns in this regime stage, and the combination has occurred 23% of the time since 2003.

The markets have been struggling for two weeks now with the Technology sector leading the move downward. In light of that, let’s examine the positioning of our QFC Self-adjusting Trend Following strategy since it trades the tech-heavy NASDAQ 100 and outperformed its benchmark during the market’s move up.

The strategy can go anywhere between 1X exposure short up to 2X exposure long. It went into market highs fully long at 2X exposure. Starting in the first week of September, the strategy reduced long exposure to 1.2X. On September 8, it reduced its exposure even further to 0.8X and remained there to close out last week. The positioning proved to be a good decision in a week where the NASDAQ 100 was down 4.60%. The strategy ended the week with a loss of 5.05% after fees. Considering how aggressively the strategy was positioned during the market highs, the quick adjustment of the strategy when risk was recognized is a great example of how our strategies react to what the market is signaling to us when making trading decisions.



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