Our Risk Odometer improved another several notches this month, moving from +3 in March to +5. As a result, we are upgrading our Outlook for a third consecutive month to “Positive”.
The warning signals our Risk Odometer gave us in December served us well, but those warning signs have largely faded. There are still indicators near inflection points and the duration of the economic expansion continue to worry pundits, but the objective nature of the Odometer points to far greater positives than negatives. For this reason, we have moved to a “Positive” Outlook. We have raised our equity allocation in our flagship tactical asset allocation strategy from 60% last month to 85% in April, coinciding with these improvements.
The rapid pace of changes in the Risk Odometer over the past six months is unusual. Yet, from politics to stock market moves, unusual has lately been more common than usual. In this kind of environment, it is easy to get caught up in the emotions of the markets. Late night presidential tweets, dramatic market movements, trade wars etc. can cause a lot of anxiety for investors and elicit emotional driven decisions. This makes it more important than ever for investors to divorce themselves from those emotions and remain objective and disciplined with their investment decisions. This is where our Risk Odometer can be useful.
The recent improvements in the Risk Odometer have been driven by improvements in Technical Price Action and Breadth. These indicators are technical in nature and have been buoyed by the improvements in the prices of stocks and the breadth and volume of those improvements. While the overall improvements to the Odometer are widespread, the technical indicators remain near inflection points and can change quickly. Economic Indicators and Earnings are positive but decelerating due to waning effects of tax cuts and slowing global growth. This could cause them to change in the later half of this year. For now, though, they remain positive. We will continue to monitor these risk signals and report them objectively.
Our biggest area of concern continues to be slowing economic growth. Higher interest rates and waning stimulus from tax cuts is a major cause of this slowdown. The second half of 2019 will be key. It should provide a better picture whether the slowdown is temporary or the beginning of something bigger. Major bear markets (declines >30%) rarely occur without more pronounced slowdowns and recessions. We are not there yet, but it will inevitably occur. Given we are 10 years into the current expansion, and the average expansion lasts ~8-10 years, time is not on our side. For this reason, we believe investors should be sensitive to early warning signs of slowing growth.
As always, we continue to believe our Risk Odometer provides guidance in making better investment decisions because it keeps us objective and disciplined. We use this methodology and advise our clients to do the same. Emotions are our enemies in investing.
It is important to understand that our Risk Odometer is not designed to anticipate small to medium corrections, typically those in the 5-15% range. Instead, it monitors for conditions which have typically preceded larger corrections. We believe trying to anticipate small to medium corrections sounds attractive but more often results in lost opportunity than savings.
The Equity Market Risk Odometer is our guide for judging risk in the equity market. It is used as a guide for investment decisions in The Core Equity Strategy. It is composed of various indicators based on leading economic indicators, earnings, technical price action, breadth, volatility, sentiment and reportable positions from the Commodities Futures Trading Commission. Its score can range from +7 to -7. Readings greater than 1 are positive and readings less than or equal to zero are negative.
This information does not have regard to the specific investment objectives, financial situation and the needs of any specific person who may view this information. Statements, opinions and forecasts made represent a particular observation and assessment of the market environment at a specific point in time and are not intended to be a forecast of future events or a guarantee of future results. Statements regarding future prospects may not be realized and may differ materially from actual events or results. Past performance is not indicative of future performance.
Each investment type has different investment risk characteristics. Risk is the variability of investment returns.
An investment in a money market fund is not insured or guaranteed and seeks to preserve the value of your investment at $1.00 per share. It is possible to lose money by investing in a money market fund.
U.S. Treasury bonds are guaranteed as to the timely payment of principal and interest.
TIPS offer a lower current return to compensate for the inflation protection. TIPS are tax inefficient and should belong in tax-deferred accounts.
Tax-exempt municipal bonds offer the opportunity to maximize your after-tax return consistent with the amount of risk you're willing to accept. Municipal bonds offer a higher net yield to investors in higher tax brackets. Municipal bonds may be subject to AMT.
Corporate bonds are considered higher risk than government bonds. Corporate bonds have higher interest rates than government bonds. The higher a company's perceived credit quality, the easier it becomes to issue debt. High yield bonds experience higher volatility and increased credit risk when compared to other fixed income investments.
Bonds have fixed principal value and yield if held to maturity. Prices of fixed-income securities may fluctuate due to interest rate changes. Investors may lose money if bonds are sold before maturity.
REITs do not necessarily increase and decrease in value along with the broader market. However, they pay yields in the form of dividends no matter how the shares perform based on different criteria than stocks.
Stocks can have fluctuating principal and returns based on changing market conditions. The prices of small company stocks generally are more volatile than those of large company stocks. Growth stocks are more volatile than value stocks.
International investing involves special risks not found in domestic investing, including increased political, social and economic instability. Investing in emerging markets can be riskier than investing in well-established foreign markets.
The price of physical materials is subject to supply and demand.
It is not possible to invest directly in any index. The performance of an unmanaged index is not indicative of the performance of any particular investment. The performance of an index assumes no transaction costs, taxes, management fees or other expenses. Past performance does not guarantee future results.
Sector investing that concentrate its investments in one region or industry may carry greater risk than more broadly diversified investments.
There is no assurance that by assuming more risk, you are guaranteed to achieve better results.
Historical performance relative to risk and return points to, but does not guarantee, the same relationship for future performance.
Diversification through an asset allocation plan is a useful technique that can reduce overall portfolio risk and volatility. Diversification neither ensures against a profit nor protects against a loss. Diversification offers returns which are not directly related over time and is intended for the structure of a whole portfolio to reduce the risk inherent in a particular security.
Data Source: YCharts
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Michael Fickell is an investment advisor representative of FC Wealth Solutions
Securities and investment advisory services offered through FC Wealth Solutions, a registered investment advisor.