The major stock market indexes fell last week. The Dow Jones Industrial Average lost 3.3%, the S&P 500 Index fell 2.9%, the NASDAQ Composite dropped 1.9%, and the Russell 2000 small-capitalization index fell 2.8%. The 10-year Treasury bond yield fell almost 5 basis points, as Treasury bonds gained ground for the week. Last week, spot gold rose 1.57%, behaving like a safe-haven asset as stocks took a break from their recent climb.
The market was trending higher in the early part of last week, leading to recent market highs. However, the market began to turn on Wednesday (June 24), and the S&P lost more than 2% on Friday. As the following chart shows, drops of that amount on a Friday are typically very bullish for the Index, particularly over the past 10 years, which may lead to some optimism in the coming days.
The markets continue to focus significantly on the latest COVID-19 news, attempting to digest the latest breakthroughs and hopes for medications; case numbers in fully open states, such as Arizona, Florida, and Texas; and government policies attempting to slow its spread. It’s a lot to take in for medical professionals and financial professionals alike. While the market has been fairly optimistic that the U.S. will emerge from the pandemic somewhat unscathed, it is pausing to digest incoming news, which may require caution going forward.
The bad news
One of the big negatives is the recent surge in coronavirus cases (partial paywall) in states such as Arizona, Florida, and Texas.
The economic policies that guided these states were intended to mitigate the impact of the pandemic on the states’ economies while keeping cases low enough that the local health-care system could handle them.
At least preliminarily, there seems to be some evidence that despite having no restrictions on work, economic contraction is still occurring now that cases are spiking. In Texas and Arizona, some businesses have begun closing (both voluntarily and mandated by the government) in response to these spikes, so it remains uncertain whether the pandemic can be controlled enough to allow the health-care sector to handle the caseload while only minimally impacting economic output. This is evidenced by the reduction in “homebase hours” in both states as cases have spiked (shown in the previous charts).
The good news
However, all of these dark clouds have a bit of a silver lining. The development of a COVID-19 vaccine, as well as drugs to treat the virus, continues at a quick pace. Additionally, the nationwide death rate for the disease continues to fall and has decreased by half in many areas due to an improved understanding of the progression of the illness and more rapid delivery of treatment.
The Fed’s take
Of course, this is a lot for even for the medical industry to take in, so it’s no surprise that the market struggles to find direction—and will probably continue to do so in the intermediate term.
While the news is mixed, the pandemic will be with us for some time. In response, the Fed appears prepared to support the markets until the crisis has abated. The consensus is that the Fed will not begin increasing rates until 2023, giving us time to find a cure or vaccine for the virus and for that change to work its way through the economy, as there will likely be a lag between a cure and a change in consumer behavior. This means the recovery may be more U-shaped—not the V-shaped recovery some analysts predicted (though a breakthrough medication or vaccine could easily change expectations going forward).
To that end, analysis of the Fed’s meeting minutes shows a continued dovish approach, with a slight trend toward hawkishness as the economy has picked up off its recent lows due to the widespread lockdowns.
A look at other indicators
Investor sentiment continues to be relatively negative, despite recent gains in the market. Another week saw significant outflows of equity funds into bond funds. This trend has been true for the past week, month, quarter, and year, with the pace relatively unchanged for bonds. However, there were significantly more outflows last week than in the previous three weeks in equities. Additionally, the University of Michigan sentiment index fell in June as the number of COVID-19 cases rose. In short, the market is nervous.
It is clear that the world will continue to face significant uncertainty going forward. What is less clear is whether the market will respond negatively to this uncertainty given the Fed’s strong support and the breakthroughs coming from the medical industry.
Flexible Plan update
Our intermediate-term tactical strategies remain uniformly positive, although to various degrees. The Volatility Adjusted NASDAQ (VAN) strategy has a 120% exposure to the NASDAQ (up from last week), the Systematic Advantage (SA) strategy is 93% exposed to the S&P 500 (down from last week’s numbers), our Classic strategy is in a fully invested position, and our Self-adjusting Trend Following (STF) strategy increased to 160% invested. Our short-term QFC S&P Pattern Recognition (PR) strategy is currently neutral. VAN, SA, STF, and PR can all employ leverage—hence the investment positions may at times be more than 100%.
Among the Flexible Plan Market Regime indicators, our Growth and Inflation measure continues to show that we are now in a Deflation economic environment stage (meaning a negative monthly change in the inflation rate and negative monthly GDP reading). Quite often, these deflationary readings occur after equity bear markets, as there is a lag in reporting and the stock market anticipates future returns for companies. Ironically, a deflationary reading may be a bullish sign when coupled with recent market movements.
Our Volatility composite (gold, bond, and stock market) is showing a High and Rising reading, which favors equities over bonds and then gold, although all have positive returns in this regime stage.
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