The major stock market indexes were mixed last week, with some further consolidating gains seen this year. The NASDAQ 100 Index (the laggard for the week) was down 1.4%, the S&P 500 Index fell 0.6%, the Dow Jones Industrial Average lost 0.03%, and the Russell 2000 gained 2.6%. The 10-year Treasury bond yield rose about 3 basis points, as Treasury bonds fell slightly for the week. Last week, spot gold rose slightly, gaining 0.4%.
Politics, pandemic concerns, and seasonality could bring more volatility
The market continues to consolidate, though the amounts lost are incomparable to the losses earlier this year. Once again, large-cap growth companies fell the most last week, while smaller companies gained. Quite a bit of the market turmoil last week appears to be the result of sector and style rotation for investors, as the market takes a bit of a breather. For example, the Energy, Industrials, and Materials sectors were up last week, while Consumer Discretionary, Consumer Staples, Communication Services, and Technology were down. Sectors were fairly evenly split between rising and falling last week.
As in past weeks, last week’s losses don’t appear to be due to any fundamental changes in the market. Increased volatility and market losses tend to be quite common at this time of year, with volatility decreasing significantly after that through the end of the year. However, we do have a bit further to go before the typical period of volatility is over.
It’s also quite likely that this year’s political and pandemic tensions—and all of the major unknowns that come with them—will further exacerbate market volatility going forward. Typical investor behavior leading to this seasonal volatility may also add to market volatility for the next few weeks. Diversification and risk management will be key portfolio protectors going forward.
Fed meeting triggers sell-off
The Federal Reserve’s FOMC meeting appears to have been the precipitating factor in last week’s sell-off. Markets topped shortly after the meeting and then subsequently dropped by varying degrees. This was despite little change in expectations going forward. It appears that investors were looking for an excuse or signal to initiate trades. This has led us to the third straight week of losses for the S&P and NASDAQ.
Transports and emerging markets indicate a positive market outlook
Transports have done increasing well and were actually up over 1.3% last week. Some believe that transports lead the market overall, so a positive divergence of this segment of the market would be good news. Year to date, transports have outperformed industrials by over 7%. Furthermore, the demand for copper has continued to increase, with the metal gaining 1.7% last week and about 6% year to date. Both transports and copper are often considered leading indicators, so their recent performance suggests that the market anticipates further economic recovery.
Interestingly, emerging markets also performed well last week, gaining 1.3%. In a true risk-off scenario where the market is seeking safe-haven assets due to a significant market sell-off, emerging markets tend to lead the way down. We didn’t see this last week—either in emerging markets or domestic small-cap stocks.
Gold’s performance as a hedge
Lately, gold has not been providing the hedge to equity market movements that it often does. The reasons for this are complicated, but we can simplify a bit.
Gold tends to move inversely to real interest rates; that is, when real interest rates increase, gold decreases in attractiveness and falls in price. Inversely, when real interest rates fall, gold becomes relatively more attractive and prices improve.
Currently, nominal interest rates are extremely low, with the Fed supporting the markets in the face of a COVID-19 pandemic headwind. Additionally, inflation expectations are high going forward because monetary and fiscal policies are attempting to supply the same market support. In combination, these conditions make real interest rates exceptionally low (and actually negative at present), which typically makes gold attractive as a hedge for inflation.
This view of gold as an inflation hedge rather than a safe-haven asset class has led to some interesting correlations with equities. It has recently become a “risk-on” asset. Improvements in the economy indicate that inflation is likely to come sooner rather than later, and nominal interest rates are likely to stay where they are for the next few years, according to the Fed. This has resulted in scenarios where positive economic news leads gold to increase along with equities, and negative news (also typically indicative of a lack of inflation at the present moment) leads the metal to fall.
These circumstances are temporary, and the metal’s correlation with equities will likely revert to a more typical configuration. Over the long term, gold has had almost no correlation with equities, and we expect that long-term relationship to remain true despite any recent deviation.
Flexible Plan update
Our top-performing strategies for the week were dominated by those with international or alternative asset classes. The major exception was our WP Aggressive strategy (+1.6%), which was our biggest gainer for the week. Among our Quantified Fee Credit (QFC) strategies, the QFC Evolution Plus strategies and QFC Select Alternatives did the best.
Among the Flexible Plan Market Regime indicators, our Growth and Inflation measure continues to show that we are now in a Stagflation economic environment stage (meaning a positive monthly change in the inflation rate and negative monthly GDP reading), though we do expect a reversion to a more normal market environment. In the current regime, gold tends to perform the best, followed by bonds, and then equities.
Our Volatility regime is showing a High and Rising reading, which favors equity over gold and then bonds, although all have positive returns in this regime stage.
PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. Inherent in any investment is the potential for loss as well as profit. A list of all recommendations made within the immediately preceding twelve months is available upon written request. Please read Flexible Plan Investments’ Brochure Form ADV Part 2A carefully before investing. View full disclosures.