Our Risk Odometer has improved another notch this month from +2 to +3. As a result, we are upgrading our Outlook for a second consecutive month from “Use Caution” to “Cautiously Positive”.
Our Outlook turned to Defensive in mid-December, giving a timely warning signal to a sharp sell-off shortly afterwards. 2019 has been dramatically different. The stock market has experienced the best two-month start to a calendar year in almost 30 years! This is mainly attributable to a more dovish stance (fewer rate hikes) from the Federal Reserve and positive developments on the trade war front. Our Odometer has also picked up on these positive signals, going from 0 in December to +3 today and our Outlook continues to improve.
Last month we described our Outlook as a “one foot in, one foot out” stance and stated our proprietary strategy reflected this with an equal allocation to stocks and bonds. Our current Outlook still maintains a “one foot in, one foot out” stance, but the “one foot in” is now in a little further given the positive upgrade. Our allocation to stocks in our tactically managed flagship strategy has increased from 50% to 60% and will continue to increase if our Outlook remains “Cautiously Positive” and our Odometer does not flash new warnings.
The improvement in our Risk Odometer has been driven by an upgrade in our Technical Price Action indicator. Improving technical price action along with still positive Economic Indicators and Earnings warranted an upgrade in our Outlook. With a net score of +3, it is still far from the +5-6 range in mid-2018 when our Outlook was “Positive”.
Our biggest area of concern is 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.
The upgrade in our outlook still maintains a degree of caution and investors should expect some level of volatility this year. The beginning of 2019 has recovered a majority of the late 2018 sell-off and our Outlook has improved, but there are still areas of concerns. Most importantly, we are closely monitoring slowing company earnings and economic growth. These major fundamental drivers are not flashing recession warnings yet, but the weaker growth rates in them does raise caution. We are more sensitive than normal given the duration of the current expansion.
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.