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Our Risk Odometer remains unchanged at +1 in August, and we maintain our “Cautiously Positive” Outlook. We continue to witness negative fundamental indicators and positive technical indicators. Our positive technical indicators outweigh the negative fundamental indicators for now.
We are slowly growing more confident in our Cautiously Positive outlook. The caution stems from our positive signals being technical indicators, which can quickly change if sentiment abruptly changes, which we felt would come from the economy slowing further. The economy remains remarkably resilient though, and actually gained steam in the second quarter rather than continuing to slow. For our confidence to grow we would need to see an improvement in fundamental signals. We maintain a Cautiously Positive outlook because a net positive score warrants it. We will become more confident with an improvement in fundamental indicators or more cautious if technical indicators deteriorate.
Our most robust fundamental indicator, Leading Economic Indicators, has declined for fifteen consecutive months, the longest consecutive decline since just before the 2008 recession. Leading Economic Indicators has a tremendous track record of sending warming signals in advance of recessions. This time could be different, or the lags could simply be longer. Our instinct is with the latter. Many economists still predict a mild recession in the second half of this year or early next year, but the number of economists calling for one are being reduced and/or the timing pushed back. We continue to believe a recession is on the horizon, but the timing is less certain and further away.
Another reason for our tepid confidence is the lack of participation in this year’s stock market rally. Widely quoted stock market indices are being led by very few names. The breadth of this rally has broadened over the past few months, but leadership still remains narrow. Stock market gains led by a small number of stocks often do not have the same follow-through strength as a market led by a large number of stocks.
We strike a bit of caution with the artificial intelligence craze that has dominated markets this year and advise investors to be patient and cognizant of the prices they are paying. We believe AI will be a major disruptor to the technology world and some stocks will continue to notch large gains in future years. Our caution lies in the FOMO (fear of missing out) factor that causes investors to disregard the price they are paying for an investment. FOMO periods can power markets higher and last a long time, but they rarely end in the average investor obtaining riches. It was not long ago that the FOMO factor powered many cryptocurrencies to unbelievable levels in 2021 only to crash in 2022.
We want to be clear that although we have some near-term caution, we still believe the stock market is one of the best ways to grow your wealth. The boom-bust characteristics of our economy can cause the stock market to be very volatile over short periods of time. Long-term investors should view periods of volatility as opportunities to buy attractive assets at attractive prices and improve long-term returns. The Risk Odometer is our objective way of mitigating that volatility, so it does not lead us to make poor short-term investment decisions.
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 our proprietary investment strategies. It is composed of various indicators based on leading economic indicators, earnings, technical price action, breadth, and volatility. Its score can range from +5 to -5. Readings greater than one 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.