Market insights and analysis

By Tim Hanna

The major U.S. stock market indexes mostly declined last week. The S&P 500 decreased by 0.10%, the Dow Jones Industrial Average gained 0.63%, the NASDAQ Composite was down 1.10%, and the Russell 2000 small-capitalization index lost 2.66%. The 10-year Treasury bond yield fell 16 basis points to 3.31%, taking Treasury bonds higher for the week. Spot gold closed the week at $2,007.91, up 1.96%.

Stocks

Only the Dow Jones Industrial Average advanced during last week’s holiday-shortened week; however, the S&P 500 did not lose much of its momentum from the previous week. Small-cap stock lost over 2.50% and money moved into blue chip stocks, signaling that investors have renewed growth concerns that could translate into cuts in earnings estimates. Gains came from defensive sectors, while cyclical sectors saw the largest losses on the week.

On the economic data front, ISM Manufacturing PMI came in at 46.3, less than the 47.5 forecast. Values below 50.0 indicate industry contraction, while values above 50.0 indicate industry expansion. ISM Services PMI was 51.2, below expectations of 54.3. Unemployment claims were 228,000, while consensus expectations were 200,000. Nonfarm employment change came in at 236,000, higher than the 228,000 expected. Average hourly earnings month over month were in line with expectations of 0.3%. The unemployment rate printed at 3.5%, slightly less than the 3.6% forecast.

The S&P 500 Index held above both its 50-day and 200-day moving averages last week. The majority of year-to-date price action has been above the 200-day moving average, and the golden cross (when the 50-day moving average crosses above the 200-day moving average) from late January remains in play. Market technicians consider price action above the 50-day and 200-day moving averages to be a bullish signal. Breakouts of year-to-date highs could indicate a continuation of the trend to the upside over the intermediate term.

Last year was challenging for investors, especially passive investors who rely on historical diversification benefits between stocks and bonds. Traditionally, the two asset classes are considered uncorrelated. During times of equity volatility, they have exhibited inverse correlation that helped offset equity losses. Last year, investors did not see much of that benefit as stocks and bonds had a correlation coefficient of 0.32 during 2022. (Correlation coefficients, which range in value from 1 to -1, measure the strength of the relationship between two variables. A value of 1 indicates a direct relationship, a value of -1 indicates an inverse relationship, and a value of 0 indicates no relationship.) Partly a result of inflation and the Federal Reserve’s rate-hike policy, bonds went down in price regardless of credit quality and duration. They also did little to offset the effects of equity market volatility within a portfolio.

However, year to date (YTD), the historical relationship may be seeing signs of a return, at least in the short term. The one-month rolling correlation has hit its “most inverse” relationship in over a year. As of last week, it registered -0.6 YTD.

So far, markets have been less volatile this year than last. Even through the collapse of Silicon Valley Bank, bonds did help offset equity loss more than they did last year. A major contributor to this has been the slowdown, and recent reversal, in yields. The 10-year Treasury recently closed at a six-month low.

Bespoke Investment Group looked at historical performance data to determine the significance of the end of the 10-year Treasury’s streak without a six-month closing low. The recent streak of 664 trading days is the longest on record since 1962 (historical recessions are shaded in gray in the following chart). While most of the previous recessions shown in the following chart were preceded by an extended streak, many of those streaks weren’t immediately followed by a recession.

The following table lists the periods when the 10-year yield went a year or more without a six-month closing low. For each period, the forward performance of the S&P 500 and the 10-year yield is included. The end of previous streaks was typically followed by further declines in yields. The 10-year yield was down on a median basis three, six, and 12 months later. After the last six streaks ended, the 10-year yield continued lower six and 12 months later each time.

While yields tend to decline after a streak, equities tend to rally. Three months later, the S&P 500 was higher almost 75% of the time by a median of 4.3%, over 2% higher than the historical average for all three-month periods since 1962. Six and 12 months later, the Index was higher 80% of the time with median gains of 6.5% and 13.8%, respectively. One year later, significant declines were experienced after streaks ending in October 1973 and April 2000, but overall performance was to the upside in the data set.

Whether the correlation between stocks and bonds remains at historical norms going forward or the conditions in 2022 become more common in the market’s future, dynamically risk-managed strategies are able to respond to changing market conditions as the changes are reflected in asset prices. As markets have moved higher and experienced less downside volatility recently, a number of our momentum-based strategies have moved into and are still in more risk-on positioning. Also, non-mean-reversion strategies that were inverse a few months ago have reduced, eliminated, or even flipped their short exposure.

If prices continue higher with low volatility, systematic trend-following algorithms are designed to recognize the price momentum and participate in a risk-on fashion. If volatility resurfaces and prices turn south, systematic momentum strategies are designed to identify the change and move to more defensive positioning.

The following chart shows the two-year performance of the Quantified Managed Income Fund (QBDSX, -3.88% return, 7.29% max drawdown) compared to the iShares Core US Aggregate Bond ETF (AGG, -8.07% return, 17.82% max drawdown). The Quantified Managed Income Fund is an actively managed income fund that can seek various income classes as well as the safety of cash when market exposure is undesirable. The Fund is a key defensive component in several actively managed strategies at Flexible Plan Investments.

Bonds

The yield on the 10-year Treasury fell 16 basis points, ending last week at 3.31%.

As discussed earlier, the 10-year US Treasury yield closed at a six-month low last week for the first time since August 2020. After peaking in October last year, two attempts at new highs failed (black downward-sloping line on the following chart), potentially signaling an intermediate-term relief in the rise in rates. The 10-year Treasury experienced minimal support at its 50-day moving average (green line on the following chart) and continues to trade below its 50-day moving average since the break in early March.

T. Rowe Price traders reported, “Investment-grade corporate bonds were supported by relatively limited new issuance, although performance was mixed across sectors. Bonds in the energy sector were early outperformers on news of a production cut by OPEC and other oil-producing nations, while U.S. and Yankee banks (banks domiciled in the U.S. but with most of their operations elsewhere) lagged the broader market.

“The high yield bond market was mainly focused on issuance, as several new deals were announced after a very quiet month of March for the primary calendar. Most new issues were met with solid demand. Energy names traded higher following news of the proposed OPEC+ oil supply cuts.”

Gold

Gold locked in a gain of 1.96% last week. The metal continues to see strength in its substantial upward move that started from its breakout in mid-November, setting a 52-week high last week.

Gold is now trading well above its 50-day and 200-day moving averages. Very little selling pressure has been seen since the recent leg up that started in March.

Until November, the U.S. dollar’s strength (the purple line in the following chart) had made it difficult for gold to rally. A strong dollar is a restraint on global liquidity and a headwind for inflation in the U.S. In general, a stronger dollar lowers the price of imports. During gold’s recent uptrend, investors have continued to see the U.S. dollar pull back. The U.S. dollar and other non-equity or bond exposures are available asset classes for consideration within certain strategies at Flexible Plan Investments.

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

The indicators

The very short-term-oriented QFC S&P Pattern Recognition strategy started last week with 120% short exposure. Exposure changed to 150% short at Monday’s close, 130% short at Tuesday’s close, and 80% long at Wednesday’s close. Our QFC Political Seasonality Index favored stocks last 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 40% long exposure to the NASDAQ and changed to 60% long at Thursday’s close. The Systematic Advantage (SA) strategy is 30% 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 moved into stocks at Tuesday’s close 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 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 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 lower returns and higher volatility for all three major asset classes.