Market insights and analysis

By Jerry Wagner

Market Snapshot

•  Stocks: The major market indices finished mixed last week. The Dow Jones Industrial Average lost 0.32%. The S&P 500 Stock Index rose 0.33%, while the NASDAQ Composite climbed 1.14%. The Russell 2000 small capitalization index gained 0.97% last week.
•  Bonds: The 10-year Treasury bond yield fell 14 basis points to 4.09%. Bonds rallied. The U.S. Aggregate Bond ETF (AGG) gained 2.26%. TLT, the 20-year Treasury Bond ETF, jumped 2.65%.
•  Gold: This week gold futures closed the week at $3,644.22, up $128.10 per ounce, or 3.64%. The U.S. Trade-Weighted Dollar finished the week essentially unchanged.
•  Market indicators and outlook: Technical indicators are mostly positive for stocks, as are the strategies. The economic environment is classified as Normal, favoring gold and stocks from a return perspective. Volatility is Low and Falling, a regime historically favorable for stocks over other asset classes.

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 

Last week, stocks defied the usual September warning and moved generally higher. The recent uptrend line has held and new highs were hit on a number of major indexes.

However, with the new highs comes overbought conditions that make some sort of a correction more likely. As you can see on the chart above, the S&P SPY ETF has moved to the top of the light blue shaded portion of the chart. That marks a standard deviation of 2. Usually, this level of volatility encompasses 95% of the prior period outcomes. As is also visible on the chart, in most cases this level has signaled the beginning of a retracement down at least to the darker blue shaded area. While there are exceptions to his rule, it does suggest some caution as we move deeper into September’s negative seasonality.

On the economic front, the economy continues to issue mixed signals. The ISM Services report beat expectations, while its companion Manufacturing measure continued to sink. At the same time, inflation, while stable within the commonly published standards, continued to warn on some of the more peripheral measures. The latest jobs report also was mixed, with most of the internal numbers as well as the headline unemployment rate increased slightly, but the level of the jobs growth was disappointing.

These mixed messages do not make the Federal Reserve’s job any easier. But I think we need to take Fed Chairman Powell at his word, and assume that the Fed will begin lowering rates at next week’s meeting. This, too, is generally regarded as positive for stocks, but any gains from expectations of such an event are most likely in bonds in the short run.

Regardless of next week’s Fed action, as we have been reporting all summer, its actions behind the scenes have been infusing liquidity into the markets via its SOMA (System Open Market Account) activity, the Fed’s portfolio of assets used to fund its monetary policy. This continued last week, and remains bullish for stocks.

Finally, I should note that while September is often reported as negative in seasonality terms, over the last 20 years next week has generally been the most positive of the month.

The bottom line: Stocks continue to signal higher prices by year end. But as the chart above demonstrates, caution is now advisable in the short term and actively managed strategies are recommended.

Bonds

Yields continue to fall! As is evident in the chart above, yields broke below their moving average support back in July, and while there have been short-term rallies, the pace has been generally lower, even resulting in a death cross pattern (the 50-day moving average moving below the 200-day) at the start of last month. Yield’s downward trajectory seems likely to continue until at least the Federal Reserve meeting.

As a result of yields moving lower, bonds have rallied. In fact, measures of trend among all of the major bond indexes have now signaled higher prices for the immediate future. A return to April’s high may soon be in store.

Meanwhile, the high-yield bond market continues to move higher with stock prices. The tail wind from both stocks and bonds is pushing this hybrid bond higher. The trend favors this asset class through year’s end.

Gold

The economic and bond market trends continue to favor gold. The weak jobs report was just one example.

And gold has responded. It has been setting new all-time highs on a daily basis for quite some time now. This break out seems likely to increase, as central banks continue their purchases, inflation heats up, and bond yields trend sharply lower.

Normally, we would see new highs by gold with the U.S. dollar sinking. That has not been the case this time around. Instead, while the dollar did decline in early August, for most of the rest of the month and into September the greenback has stabilized in value. Still, it seems likely that with the push higher in gold prices, the dollar will soon resume its downward trajectory.

FPI is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX). Introduced 12 years ago, the fund is designed to track the daily price changes in the precious metal and provide more tax efficiency than its ETF counterpart, GLD.

The Indicators

The short-term technical indicators of future stock market price changes I watch are now mostly positive. And our QFC S&P Pattern Recognition strategy ended the week holding a 1.40% exposure to the S&P 500 Index.

Our QFC Political Seasonality Index (PSI) strategy has been out of the stock market since its close on September 3. It returns to a fully invested position at the close on September 29.

Our QFC Political Seasonality Index strategy was aggressive throughout last week. (Our QFC Political Seasonality Index—with all of the daily signals—is available post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.)

FPI’s intermediate-term tactical equity strategies maintain their positive bias. Classic continues 100% long equities. The Volatility Adjusted NASDAQ (VAN) strategy finished the week at a 140% net long exposure to the NASDAQ 100 his week. Systematic Advantage (SA) ended the week 90% net long. Our QFC Self-adjusting Trend Following (QSTF) strategy remains in a 200% invested position since the close on May 13. Our newest strategy, QFC Dynamic Trends (DT), after outperforming the S&P 500 in the second quarter, also remains 200% invested in stocks.

Because the Volatility Adjusted NASDAQ, Systematic Advantage, QFC Self-adjusting Trend Following, and the QFC S&P Pattern Recognition strategies can employ leverage, the investment positions may exceed 100%.

FPI’s Growth and Inflation measure, one of our Market Regime Indicators, shows that markets are in a Normal economic environment stage (inflation and GDP are growing). Historically, a Normal environment has occurred 60% of the time since 2003. In a Normal climate, Gold outperforms stocks and bonds on an annualized return basis, but it also carries the most downside risk. From a risk-adjusted perspective, Normal is one of the best stages for bonds, followed by Gold and then stocks.

Our S&P volatility regime is registering a Low and Falling reading. This environment favors stocks over gold and bonds from an annualized return standpoint. It is the strongest regime for stocks, both on an absolute, and risk adjusted, return basis. While, gold has rallied into its riskiest, as well as its lowest risk adjusted return, period. The Low and Rising combination has occurred 37% of the time since 2003.