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Our Risk Odometer moved lower in January from -1 to -3. Our Outlook remains “Defensive”. Last month we had expressed hope that the stock market rally in October and November would signal better times ahead but were doubtful it would given the weight of the other evidence. Our doubt overcame our hope and the market’s difficult December turned our Risk Odometer further into negative territory.
The weight of the evidence approach is key to our assessment of the markets. Technical indicators such as price action and volatility are often the first indicators to express potential turning points, but when these indicators are not confirmed by other indicators, they often give false signals. We were hopeful we would not experience that, but those early positive signals crumbled in December under the pressure of a slowing economy and slowing earnings.
Another negative signal, an inverted yield curve also remains present. An inverted yield curve occurs when short-term rates are higher than long-term rates. An inverted yield curve is very rare and has preceded the start of the last eight recessions in the US. Although the slope of the yield curve is not an input to the Risk Odometer, we do consider it when making overall assessments of the outlook.
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 also flush out many investors, leaving 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. This is what our Risk Odometer helps us do. We use it mitigative downside losses during turbulent times so we can remain invested and experience the large gains that often follow.
Although we do 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 one given the strength of the labor market and overall reduced supply in 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 wish we had a crystal ball that would tell us if our mild recession prediction will come true. Unfortunately, we do not. We defer to following facts rather than predictions, therefore, remain defensive until we get some positive signs from our Risk Odometer.
We want to be clear that although our Risk Odometer is defensive, we are still a long-term believer that 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.