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We have moved our Current Outlook down one notch, from “Positive” to “Cautiously Positive”. Although the coronavirus has caused volatility and fear to start the year, this is not the reason for the downgrade in the outlook. The downgrade was caused by something much more concerning…weakening fundamental indicators.
The coronavirus, the respiratory virus originated in China, is scary. At the time of this writing, it has infected over 20,000 people with a death toll of over 400. The numbers continue to climb every day. The World Health Organization has declared it a medical emergency, and there is no known cure yet. News of the disease has created a classic “risk-off” episode in the markets, whereby investors sell stocks and buy safe-haven assets such as treasury bonds. The economic effects are not known yet but it will surely impact global GDP data.
The outcome of the coronavirus is a major uncertainty and markets hate uncertainty. Looking at historical instances of global disease outbreaks and other unforeseen economic casualties, markets have typically responded in a ‘V’ shaped pattern, meaning they take a quick, hard loss but recover quickly in a ‘V’ shaped pattern. The outcome this time is, by no means, a certainty, but history can give us a good guide to building probabilities. My guess is the short-term hit to economic activity will result in pent-up demand that will fuel a recovery.
The real cause for the downgrade to the Outlook is the deterioration of our fundamental indicators, Leading Economic Indicators and Earnings. Our Earnings signal, which had been positive for four years turned negative last month. It has been upgraded to neutral this month due to some better than expected earnings reports last quarter. Sitting on an inflection point, it can easily move to either positive or negative, not something it has done in four years.
This month, our Leading Economic Indicators signal turned negative for the first time in 8 years. The lagged effects of the trade war with China have continued to pile up and we are now seeing this in the deterioration of the data. Most economists are discounting the recent weakness given the improvement in the trade war (signing of Phase I). The Fed is on the same bandwagon, calling the recent weakness a “mid-cycle slowdown”, insinuating stronger growth lies ahead. Economic data is backward-looking but objective. For the first time in a long time, it is sending warning signals. This is the major cause for the downgrade in the Outlook.
Personally, I agree with the temporary slowdown argument. Unemployment rates remain low and inflation is not a problem. I believe the current administration will do everything in its power to keep the economy strong and the markets high to improve its reelection chances. Our technical indicators (Price Action, Breadth and Volatility) are all still positive and the stock market continues to trade near all-time highs. This is offsetting the weakness in fundamental indicators. Nevertheless, the current administration cannot control everything, and some fundamental warning signals are present, hence the small downgrade to our Outlook to “Cautiously Positive”.
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.