Market insights and analysis

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

2nd Quarter | 2022

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

By Jerry Wagner

Normally when an adviser claims, “This time is different,” they are trying to make the opposite point. Usually, the phrase is used to deride bullish investors who are claiming that all of the excesses leading to a booming stock market won’t turn out to be harbingers of a nasty correction in the not too distant future.

Numerous articles along these lines have been written near the end of most bull markets—and sometimes in the middle and near the beginning of some bull runs. They are proven wrong with just a little bit of hindsight.

In other words, nobody is right all of the time, and it is hard to put market moves in perspective. It’s also why market timing is so difficult.

Nonetheless, I feel like the last two quarters were different in a number of ways. I don’t mean to imply that what happened in this period has never happened before. I have been investing for more than 50 years. Not only have I seen this market action before, but—even in recent years—I have been warning investors that this sort of market environment was possible.

Why do I believe this time is different? Because the last two quarters have deviated substantially from what investors have come to expect since at least 2009. In this article, I will describe those differences and discuss their implications for your investments.

The need for a safe haven

The first difference between the second quarter of this year and most previous quarters is that there was literally no place to hide as the stock market fell. This was different even from the action of the major asset classes in the first quarter.

In the first quarter, the S&P 500 tumbled 4.62% (it was down 12% just before a March bear market rally); the NASDAQ 100, represented by the QQQ ETF, fell 8.76% (20.79% at its worst); and long-term Treasurys, represented by the TLT ETF, fell 10.63%.

The traditional refuge during such stock plunges would be bonds. That’s why they are often referred to as a “safe haven.” Yet bonds fell by double digits in the first quarter.

The only true safe haven was gold. In the following graph, we can see that gold (represented by the SPDR gold ETF) actually rose in value during the first quarter. Nine years ago, we started the first (and still only) mutual fund that tracks the daily price changes of the yellow metal, The Quantified Gold Bullion Strategy Fund (QGLDX). As a result, we were able to make liberal use of the Fund in the first quarter. As we will see, that helped most of our strategies beat the traditional benchmarks for that quarter.

No place to hide

While gold provided some relief to investors in the first quarter, none of the three major asset classes provided them with any shelter from the financial storms of the second quarter of 2022. All three asset classes fell in that quarter, and they fell hard.

While gold was again the best performer, it sank 6.75%. Bonds also closed the quarter down, falling 12.59%. By far the worst performers were in the equity market: The S&P 500 tumbled 16.11%, and the NASDAQ plunged 22.44%.

I probably don’t need to tell our readers that when you have a market like this, traditionally diversified, passive portfolios do not fare well. For example, how well can a so-called balanced portfolio fare when the 60% in stocks and the 40% in bonds are both down by double digits?

It was different at Flexible Plan Investments.

When has it happened before?

I checked our database to see if we have ever had such broad-based selling across the principal financial asset classes. One of our best stores of data is maintained for our gold white paper. The latest version of the white paper is available here, and it tracks gold, bonds, and stocks back to 1972.

Since 1972, there have been 39 60-trading-day periods (the equivalent of a quarter) when all three asset classes fell. On average, when all three fall, it is a fairly moderate decline for all three: S&P 500, -2.64%; Treasury bonds, -1.89%; and gold, -3.32%.

There were only two instances where stocks fell by more than 10%: They fell a little over 11.5% in both 1974 and 1990. Yet, in the second quarter of this year, the S&P 500 fell 16.1%, setting the record for such periods.

Interestingly, a simultaneous three-asset-class decline never happened in the 2000–2002 bear market. And the two instances in the 2007–2008 bear market were minuscule, with the three asset declines averaging -1.33%, -1.30%, and -3.81%, respectively. I’m not sure whether we should take comfort in this observation or simply acknowledge that this time was different.

Reviewing the periods when all three indexes declined, I note that there were only five periods where T-bonds performed worse than this last quarter. The two worst instances were between December 1979 and March 1980, when even the 10-year Treasury bond tracked in the gold study declined by double digits (11.52%), and in 1981, when these T-bonds sank 9.8%.

What I think is significant about both of those events is that the economic environment was similar to today’s. Many experts are projecting a double-dip decline for the U.S. markets primarily spurred on by an aggressive Federal Reserve policy to raise interest rates. The same has occurred before. As Barron’s reported, “Thus, we might experience a repeat of the history of the early 1980s, when the United States experienced a double-dip recession. The initial dip occurred during the first three quarters of 1980, followed by a second dip that lasted from the third quarter of 1981 until the fourth quarter of 1982.”

Those were difficult times for all three asset classes.

How did FPI fare through the last two quarters?

With the second quarter in the books, it is interesting to see how closely the second quarter matches up with the first quarter of 2022. The biggest difference is that the first-quarter bear market had a larger rally that allowed the S&P 500 Index to finish the first quarter down just 5%, while the second quarter ended with a decline of 16%. Drawdown was in double digits in both quarters, with the first quarter seeing a 13% drop and the second quarter 20%. Meanwhile, the NASDAQ 100’s drawdown was 21% in the first and 27% in the second quarter.

Why?

While the first and second quarters were very similar in terms of the negative performance of the indexes, the performance of Flexible Plan Investments’ (FPI’s) strategies was very different.

We offer 19 different turnkey multi-strategy portfolios: five QFC Fusion 2.0, five Multi-Strategy Core, four Multi-Strategy Explore, and five Multi-Strategy Portfolios. In addition, there are 167 strategies tracked on our Strategic Solutions (SS) TAMP platform. In the table above, I’ve set forth the percentage of each of those two categories that outperformed the S&P 500 (on the left) and the NASDAQ 100 (on the right).

Notice that while most of the strategies outperformed the indexes in the first quarter, the strategies fared even better in the second quarter, which was the worst of the two. As a result, the year-to-date (YTD) percentages that encompassed both quarters were also much better than the first-quarter results.

The reason for the big improvement is, as I have pointed out many times (here and here, for example), most investment strategies are by nature reactive. The market fundamentals, technical indicators, economic measures, and trends take time to change. Real change rarely occurs overnight.

When the markets returned to their volatile downdrafts in the second quarter, we were ready. Diversification helped in the first quarter, but dynamic risk management did the job as the market evolved from a baby bear into a grizzly bear.

Why is FPI able to do so well in such dangerous times? First, we can use asset classes that rarely show up in a traditional passive portfolio. So while the three primary asset classes were declining, we were able to make use of money market accounts, U.S. dollar currency indexes, and commodities to provide safe harbors from the storm.

Second, we were able to turn to these asset classes on a tactical basis. When they began to outperform the traditional “Big Three,” we were able to move into these alternatives quickly.

Assessing your present portfolio positioning

In evaluating the performance of your accounts this quarter, I’d ask that you focus on one of our tools  that you may have not spent much time with—or even looked at before.

It’s an old standby—the pie chart page in your statement.

This page shows the percentage of your portfolio that is invested in the major asset classes at the start of the quarter and at end of each of the three calendar months within the quarter.

With this simple set of four images, you can observe two important concepts at work. First, with the many slices of the pie in each chart, you can get a sense of how diversified your portfolio is. Second, you can observe how active we are in managing your account. Notice how the allocations vary from chart to chart. That’s dynamic risk management at work for you.

Then, take one more moment and look at the last pie chart in the lower right corner of the page. That pie chart shows where your portfolio was invested on June 30, 2022.

Do you see the amount of cash? Do you see the small amount of stocks, and that the few that are perhaps held are already positioned in defensive sectors? There’s nothing for you to do to respond to market fears. We’ve already taken action and done it for you.

And we stand ready to do the same in the future, come a recession or a rally.

Dealing with market fear

Many investors are frightened by the tumult of the markets. The headlines all seem to be negative in the financial press. Even the nonfinancial news shows have added segments illustrating the current volatility. Recession talk is everywhere.

I know in such an environment it can be difficult to stay the course. After all, I’ve been investing for over 50 years. I’ve weathered lots of these storms over those years. Each one is somewhat different, but the fear they engender is the same.

When that fear hits, don’t avoid looking at your account. Use the tools we provide you and take comfort in the fact that you are likely already positioned defensively in your account.

We have not stayed the course. We’ve acted for you.

You did not invest with a passive financial adviser that would be counseling you today to grin and bear it. You are invested with Flexible Plan Investments, Ltd. We make a difference, even if “this time was different.”



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