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Our Risk Odometer improved from -3 to -1 for February but our Outlook remains “Defensive”. This is the second time our Risk Odometer has improved from -3 to -1 with the last time being in December. In December, we were hopeful the gains in the stock market would gain further traction but we had our doubts. That same hope and doubt exists currently.
We view the recent stock market gains as a seasonally driven “January effect” and a rebound from tax loss selling in December. In addition, this year’s stock market gains do not appear to be broad-based. Some sectors are experiencing losses (last year’s outperformers) while others are experiencing outsized gains (last year’s big underperformers). Broad-based rallies tend to be more sustainable. This year’s lack of a broad-based rally creates a sense it may only be a bear market bounce and adds caution to our outlook.
The large January stock market rally triggered our more responsive technical indicators to turn positive. Our less responsive fundamental indicators continue to remain defensive. This often happens when markets are at inflection points which we believe we are currently. Our bias is to remain defensive given the weight of the evidence methodology we implement.
We know at some point the weight of the evidence approach will turn positive. We are hesitant to believe it will be in the near term. Forward-looking fundamental indicators are deeply negative, and the yield curve remains deeply inverted. These signals give us caution on recent stock market gains.
We believe we are likely to experience a recession in 2023. This is not a disastrous outcome for investors though. Stock markets typically bottom during recessions not after them. Bonds and other defensive assets often experience outsized gains during recessions. Recessions leave behind attractive opportunities. The largest stock market gains often come as a result of a previous recession. The key is staying invested through turbulent times. We use our Risk Odometer to help us mitigative downside losses during turbulent times so we can remain invested and experience the large gains that often follow.
Although we expect a recession in 2023, we have been humbled before and could be positively surprised if one does not occur. If one does occur, we would expect it to be a mild given the strength of the labor market and reduced supply of labor. Without a severe recession, we would not expect to have severe stock market losses. We have already experienced a 25% drop in the S&P 500, which we believe was reflective of a mild recession. This is why we believe the lows of the market are behind us rather than in front of us. We could see a period of volatility ensuing over the next few months or quarters that could cause the markets to move towards the September lows or even pierce them, but we would view prices that low as a long-term buying opportunity.
We want to be clear that although our Risk Odometer is defensive, 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 markets 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. Easier said than done though. Volatility can cause investors to panic and make poor investment decisions and damage 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.
FC Wealth Solutions and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.
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.