Market Update 12/28/20

By Jason Teed

The markets saw some selling pressure last week as traders looked to lighten their exposure over the long holiday weekend. That combined with the doubt surrounding the passage of a COVID relief bill resulted in mixed equity markets last week: The S&P 500 fell 0.17%, the Dow Jones Industrial Average gained 0.07%, the NASDAQ Composite gained 0.38%, and the Russell 2000 led performance with a 1.72% gain. The 10-year Treasury bond yield fell 2 basis points to 0.93%, as Treasury bonds rose slightly for the week. Spot gold closed at $1,883.43, up 0.11%.

Stocks

The equity markets appeared to reflect investor caution last week. The major factors affecting market movements were the shortened trading week (which often makes traders feel pressured to take some risk off the table over the long weekend) and concern that the most recent COVID stimulus bill would not receive presidential sign-off. President Trump signed the bill on Sunday evening (12/27), in time to prevent a partial government shutdown. Ultimately, the bill’s passing will likely be a tailwind for the markets.

Despite the volatility of the markets and the economy this year, the markets have performed exceptionally well, propped up by a low interest-rate environment, low oil prices, and two stimulus bills. Indeed, valuations for the S&P 500 make the index look a bit frothy, hitting multi-year highs.

Typically, the market is viewed in terms of an average price-to-earnings (PE) ratio. Currently, this is around 30, near the highest it has ever been. Furthermore, the following graph, which shows the valuation of equities versus typical worker income growth, is quite telling. The chart shows the number of hours the average worker would need to work to be able to buy one “share” of the S&P 500 Index. This value is the highest it’s ever been, even outpacing the tech bubble of the late 1990s.

This may make investing more difficult for passive investors, as long-term equity returns tend to be lower when such valuations are reached. Still, we believe there will likely continue to be plenty of opportunity for active traders who are able to observe market trends in industries and select companies that they think will outpace the markets.

Bonds

Treasury yields decreased slightly, finishing the week down 2 points (ending at 0.93%) on the 10-year Treasury. Term spreads narrowed last week as interest rates fell, and credit spreads rose for the week, entirely due to movements on Christmas Eve. Overall, long-term government bonds and investment-grade corporates outperformed high-yield bonds, and longer-term bonds generally outperformed shorter-term bonds.

Expectations for the intermediate term are for interest rates to remain at historically low levels, leading investors to continue to seek yield in other places, likely bidding up the price of high yields and compressing the credit spread as the economy continues to recover.

Gold

Last week, spot gold closed at $1,883.43, up 0.11%. Other safe-haven assets also did well last week, primarily due to investor uncertainty. Gold continues to enjoy positive fundamentals as interest rates remain low, making the metal relativity more attractive when compared to interest-bearing assets and a weakening U.S. dollar. These fundamentals are unlikely to change in the next few years.

Gold has enjoyed a very good year in 2020, behaving as both a safe-haven asset (particularly at the beginning of the year) and as an anticipatory inflation hedge in the latter portions of the year. This could be gold’s best year since 2010.

The indicators

Our Political Seasonality Index was long for the week and will continue long throughout this week. (Our Political Seasonality Index is available post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure was also fully exposed last week.

Our intermediate-term tactical strategies are uniformly positive, although to various degrees. The Volatility Adjusted NASDAQ (VAN) strategy had a 180% exposure to the NASDAQ on Monday and increased exposure on Thursday, ending the week 200% exposed to the long side. The Systematic Advantage (SA) strategy is 137% exposed to the S&P 500, our Classic strategy is in a fully invested position, and our QFC Self-adjusting Trend Following (QSTF) strategy was 200% exposed all of last week. VAN, SA, and QSTF can all employ leverage—hence the investment positions may at times be more than 100%.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, 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 also 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 Falling reading, which favors stocks over gold and then bonds from an annualized return standpoint. The combination has occurred 36% of the time since 2000. It is a stage of medium returns for all asset classes, with low volatility overall.