For the first time since May, we are changing our Current Outlook from “Cautiously Positive” to “Positive”. This upgrade is the result of improvements in Technical Price Action, notably from improvements in international markets. Global equity markets appear to be rising in sync with domestic equity markets, an important development in how the Risk Odometer views risk.
When some equity markets rise while others struggle (which had previously been the case) it creates a level of caution in our opinion. This was a large reason why we had a “Cautiously Positive” Outlook since May. When markets rise in sync (what we are now witnessing), it tends to be a better predictor of continued gains. Over the past month, our technical signals in international markets turned positive, confirming the positive signals in domestic markets. The syncing of domestic and international technical strength is why our outlook has been upgraded to “Positive”.
The most likely culprit for the improved price action has been the market’s outlook on the ongoing trade war between the US and China. The two sides announced a mutual understanding for Phase One of a trade deal. The details have not been written and signed, but the progress of positive talks has created a positive sentiment in equity markets.
In our opinion, we believe the improved sentiment in the markets will be a boost over the short-term (3-12 months) despite our longer-term concerns which have not dissipated. With the presidential election now only a year away, we believe the current administration will need to keep market sentiment positive if they wish to win the election. The impeachment probe will continue to be a thorn in their side, but their stance has leaned on building public sentiment in favor of the current administration’s handling of the economy rather than the legality of the impeachment charges. Their thinking seems to be that if the stock market is riding high and jobs are plentiful, then the impeachment probe would fail in the Senate due to lack of public support.
For this reason, we believe the President needs to make some progress in the trade negotiations in order to keep the markets happy. This strategy appears to be the reason why they are not seeking a major trade deal but completing it in phases. Completing Phase One would score a much-needed victory for reelection efforts. November, December and January are also seasonally strong months which would add to short-term positives.
From a longer-term perspective, we do not believe things have improved. Forward looking economic data has continued to deteriorate and our Economic Indicators has turned from Positive to Neutral. The ISM Manufacturing Index has been in contraction territory (below 50) for three consecutive months and stock market valuations are still near historic high levels. The labor market has remained strong and inflation modest, which is allowing the cycle to continue to stretch in record territory. We believe the short-term positives will outweigh long-term risks, but we do remain mindful they exist. Market sentiment can change quickly, and long-term fundamentals will eventually dominate. For this reason, we believe a dynamic approach to risk, in this stage of the economic cycle, makes sense.
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.
Disclosures
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
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