We have upgraded our Outlook one notch from “Defensive” to “Use Caution”. This is the result of the indicators we monitor improving as the markets improved throughout January. Technical Price Action improved to neutral and Volatility turned positive causing the changes.
We view our Current Outlook as a one foot in and one foot out stance. Our proprietary strategies reflect this stance with equal allocations to stocks and bonds. We are at a critical stage in the markets and we do not envision our Outlook remaining here very long. We will wait for incoming data to give us a clearer outlook.
The Risk Odometer turned from “Cautiously Positive” to “Defensive” in mid-December. The timing of that call was impressive! It provided successful guidance in mitigating a substantial amount of stock market losses in the worst December since the Great Depression. The markets recovered in January resulting in our indicators showing some signs of recovery as well. The improvement is worthy of an upgrade in our Outlook. We still favor a cautious stance rather than a fully optimistic “Positive” Outlook. We still expect more volatility in the ensuing months, rather than a one-way march back to the highs.
Major uncertainties that should be resolved soon and give a clearer outlook is a resolution on the China trade negotiations and more data on whether the current economic slowdown is temporary or the beginning of something larger.
Many pundits question how long the current expansion can last. If the current economic expansion lasts through the middle part of this year (which most believe it will), it will become the longest expansion in history. The longest one to date was in the 1990’s that ended with the dot com crash in 2000.
The duration of this expansion is a serious cause of concern for us. We recognize the duration of an economic expansion is not a cause for it to end. No one knows with certainty when it will change but history tells us it eventually will. The record duration only tells us time is working against us rather than for us. This is what concerns us.
The average stock market correction following an economic contraction is ~35% from the highs. The market only corrected 19% last year. Many investors claim they will hold tight through these corrections. Our experience tells us this is much more difficult in practice. For this reason, we believe investors should have a plan dealing with it when it does arrive. The real money in the markets are made by those who can survive volatile environments. This is where our Risk Odometer can help, and why we share it with our clients and readers.
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.