Market insights and analysis

By Tim Hanna

Market snapshot

Stocks: Last week, the major U.S. stock market indexes mostly rose, but small-cap stocks lagged. Positives for equity markets include the bull market, favorable technicals, the election year, and declining inflation. Negatives include overextended markets, real interest rates, worrying leading indicators, and high valuations.

Bonds: Treasury yields fell, with the 10-year Treasury yield testing the 4% level and its 50-day moving average from below.

Gold: Gold rose 1.05% last week but has yet to set a new high above its December peak. 

Market indicators and outlook: Market regime indicators show the market is in a Normal economic environment stage, which is historically positive for stocks, bonds, and gold but with a substantial risk of a downturn for gold. Normal is one of the best stages for stocks, with limited downside. Volatility is Low and Rising, which favors gold over stocks and then bonds.

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The major U.S. stock market indexes were mostly up last week. The S&P 500 increased by 1.38%, the NASDAQ Composite was up 1.12%, the Dow Jones Industrial Average gained 1.43%, and the Russell 2000 small-capitalization index fell 0.79%. The 10-year Treasury bond yield fell 12 basis points to 4.02%, taking Treasury bonds higher for the week. Spot gold closed the week at $2,039.76, up 1.05%. 

For the latest information on our Quantified Funds, check out our weekly fund updates. You can also see the daily holdings of the funds here.

Stocks

The S&P 500 Index continued its positive momentum, setting new all-time highs last week. The Index is trading well above its 200-day and 50-day moving averages. Since the October low, the market has experienced very little selling pressure, with all pullbacks so far being short and shallow.

Last week, small-capitalization stocks underperformed due to weakness in regional banking stocks. The SPDR S&P Regional Banking ETF (KRE) fell over 7%. Mega-capitalization stocks outperformed boosted by strong earnings from leading companies like Microsoft (MSFT) and Alphabet (GOOG). The Vanguard Mega-Cap Growth ETF (MGK) rose over 2% last week. Aside from earnings, market movements were also driven by adjustments in expectations for rate cuts following strong economic data last week. Additionally, the Federal Reserve unanimously decided to keep the fed funds rate target range steady at 5.25%–5.50%. 

With the first month of 2024 in the books, Bespoke Investment Group conducted a study highlighting some pros and cons for markets going forward. The technical landscape is pretty clear: upward momentum with little volatility so far. Economic fundamentals have been quite strong, and earnings have been free of major negative surprises. Investors have been expecting imminent rate cuts, but the Federal Reserve has reiterated the need for evidence before considering a shift in policy. 

One market pro Bespoke highlighted was the current bull market, which has seen new highs in the early weeks of 2024. The bull market reached its 478th day last Friday (February 2). Bespoke believes this bull market will be dubbed the “AI bull market,” since it began just before ChatGPT’s launch in November 2022. The S&P 500 has surged almost 39% during this bull market. Although this is below the average bull market gain of 114% and median gain of 76%, it reflects the historical pattern of long and steady bull markets, in contrast to the short and sharp nature of bear markets. The old saying “the trend is your friend” favors the bull case.

Supporting and potentially extending the bullish move is the second pro: technical indicators. Bespoke’s Trend Analyzer indicates that all major U.S. index ETFs, except micro- and small-capitalization stocks, are in uptrends. The S&P 500 recently broke above its high from two years ago. Given the multi-year consolidation, the leg higher has the potential to be strong and lengthy. The 200-day moving average is on an upswing and nearing its 2022 high, leaving the window open for further breakout momentum. 

The third pro is the election cycle. The presidential cycle is now going into year four, which has historically been the second-strongest year in the four-year cycle for equity markets. Research shows that since 1928, the S&P 500 has been up in 74% of election years, with a median gain of 9.54%. Historically, the S&P 500 tends to trade sideways for the first third of the year, rally during the summer, pause in September and October, and then resume its rally in the last two months of the year. 

The fourth pro is inflation, which has returned to its target after being a major concern over the past few years. However, Federal Reserve Chairman Powell emphasized last week that further evidence was needed to confirm inflation's return to target. Thanks to large and sustained declines in the price of durable goods, the six-month core personal consumption expenditures (PCE) price index is below 2% annualized, and year-over-year core PCE is approaching 2%. Additionally, inflation in core services is rapidly slowing, though it is still above its target of 2%. As expected, rent PCE is slowing at a lag, with the six-month rent PCE at 4.8%. The Federal Reserve, contending with high inflation for years, has reiterated it needs evidence before suggesting a rate cut. From a data perspective, current levels are more similar to the pre-COVID era.

Moving to the bear cases, the first concern that investors are monitoring closely is the market’s signal of being overbought and extended. The S&P 500 is at the top of its multi-month uptrending bull price channel. Moreover, the Index has been more than one standard deviation above its 50-day moving average for the majority of the last few months. At some point, the Index will move into oversold territory again. 

The second drawback is real rates. Bespoke applied the Taylor Rule model to assess how tight policy should be in light of unemployment and inflation rates. According to Bespoke’s analysis, if core PCE rises at its six-month pace in January and February, the fed funds rate should be below 4%, meaning policy is tight and getting tighter. The model suggests that interest rates are significantly higher than inflation. The data suggests that the policy rate relative to trailing inflation is in the top quartile of the past 90 years and very high compared to the last two decades.

Another factor that investors closely monitor, due to its historical accuracy around recessionary periods, is our third concern: leading indicators. Recently, these indicators have shown patterns similar to those observed before and during past recessions. Coincident indicators that typically decline during recessions haven’t signaled yet, but leading indicators continue to flash warnings. 

The fourth drawback is valuations. The following chart shows that the S&P 500’s earnings yield relative to Treasury yields is now negative. Negative readings have been associated with bear markets for stocks the majority of the time over the last 50-plus years. The major exception was during the late 1990s when, despite a negative reading, stocks rallied before the tech bubble finally popped. Two years ago, the dividend yield of the S&P 500 was 1.36% and the yield of the two-year Treasury was 0.28%. Now, the situation has reversed: The S&P 500’s dividend yield is at 1.44%, while the two-year Treasury yield has climbed to 4.36%. The S&P 500’s forward price-to-sales ratio is now above 2.5, while its forward price-to-earnings (P/E) multiple is nearing 24. However, the equal-weight S&P 500 isn’t seeing such extended multiple readings; current readings suggest these multiples are around pre-COVID levels.

The longer-term upward trend that began in October has not shown signs of reversing. It is important to incorporate dynamically risk-managed investment strategies that can adapt to changing market conditions as the changes are reflected in asset prices. This is especially important if the momentum that began in October loses steam and prices face increased selling pressure more indicative of a “correction” rather than a “pullback.”

For example, when markets exhibit positive momentum, many of our momentum-based strategies adjust their positioning to be more risk-on. If prices continue to rise, systematic trend-following algorithms are designed to identify and participate in the upward price momentum. Conversely, if volatility arises and prices decline, systematic momentum strategies are designed to identify the change and move to more defensive positioning. Mean-reversion strategies attempt to recognize and navigate sideways market conditions, offering an uncorrelated complement to momentum-based programs, which face challenges during trend-reversal inflection points. 

Bonds

The yield on the 10-year Treasury fell 12 basis points last week, ending at 4.02%. 

The 10-year Treasury has pulled back significantly since its peak on October 19. The 10-year Treasury has mostly traded below its 50-day moving average since mid-November, currently testing its 50-day moving average from below. Price action has been consolidating around 4.00%, with potential resistance at the 50-day moving average. Technicians keep a close eye on the significant percentage levels (e.g., 3%, 4%, 5%, and so on).

T. Rowe Price traders reported, “Along with a modest upside surprise in weekly jobless claims, another factor keeping a lid on yields may have been lower-than-expected borrowing needs figures from the Treasury Department, reported Tuesday. … 

“… Several new deals were announced in the high yield market, but these were generally met with strong demand. … In the bank loan market, … the share of names trading above par began to approach more normal levels after the previous few weeks of aggressive repricing activity.”

Gold

Gold rose 1.05% last week but continues to fail to test the 52-week high set in late December. Gold has been seeing support with little momentum at its 50-day moving average over the past three weeks. The “golden cross” (when the 50-day moving average crosses above the 200-day moving average), seen by technicians as a longer-term trend signal to the upside, is still in play. However, as of the time of this writing, price is between the 50-day and 200-day moving averages. 

Failure to set a new swing high and registering a lower high versus December could be signs that this sell-off isn’t a standard pullback within a longer-term uptrending bull price channel. Technicians are keeping an eye on price action under the mid-January swing low and a potential test of the 200-day moving average for confirming signs of a longer-term trend reversal. 

Flexible Plan Investments is the subadviser to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction 10 years ago to track the daily price changes in the precious metal in a more tax-efficient manner than its ETF counterpart, GLD.

The indicators

The very short-term-oriented QFC S&P Pattern Recognition strategy started last week with 50% long exposure. Exposure changed to 80% long at Monday’s close, 60% short at Tuesday’s close, 50% short at Wednesday’s close, 30% long at Thursday’s close, and 0% exposed at Friday’s close. Our QFC Political Seasonality Index favored stocks until Wednesday’s close, when it moved to more defensive positioning. It remained defensive throughout the rest of the week. (Our QFC Political Seasonality Index is available—with all of the daily signals—post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.)

Our intermediate-term tactical strategies have been varied in their degree of defensive positioning. The key advantages these strategies offer to investors are 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 started the week with 160% long exposure to the NASDAQ, changed to 120% long exposure at Wednesday’s close, and moved to 140% long at Friday’s close. The Systematic Advantage (SA) strategy is 120% exposed to the S&P 500. Our QFC Self-adjusting Trend Following (QSTF) strategy was 200% long 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 in stocks throughout 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.

Flexible Plan’s Growth and Inflation measure is one of our Market Regime Indicators. It shows that we are in a Normal economic environment stage (meaning a positive monthly change in the inflation rate and a 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 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 Low and Rising reading, which favors gold over stocks and then bonds from an annualized return standpoint. The combination has occurred 27% of the time since 2003.