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For the first time in seven months, our Risk Odometer has changed from a net score of +1 and “Cautiously Positive” Outlook to a net score of -1 and a “Use Caution” Outlook. The 10% correction in the stock market caused enough technical damage to warrant the change.
The bout of volatility experienced in the markets the past few months is mainly attributable to the idea of higher for longer interest rates. Markets had been expecting the Fed to change their interest rate policy early next year and begin to lower rates. The realization that the Fed may follow through with their plan to leave rates higher for longer caused longer dated bond yields to move higher and stocks to sell-off. The 10-year US Treasury bond briefly touched 5% and the stock market sold off 10% from its highs.
The recent technical damage in the stock market eventually impacted our indicators, turning our breadth indicator negative. The rally in the stock market earlier in the year was led by a very small group of stocks. The Magnificent Seven, or the seven largest stocks in the S&P 500, have been attributable for all the gains so far this year. The other 493 stocks in the S&P 500 Index are collectively negative on the year. This extremely narrow rally is not a positive development. Markets are more resilient when the majority of participants are experiencing rallies.
On the more constructive side, third quarter earnings, around 75% completed so far, are showing positive signs. Year-over-year earnings have been in decline for several quarters. If Q3 does in fact turn positive, which seems most likely, this would be a positive development. Once complete and official, it would turn our negative Earnings indicator to positive and potentially offset this month’s new negative warnings. While these are predictions and not official, the point is that there are positive developments also brewing.
Despite the stock market sell-off and our Risk Odometer turning negative, the real economy continues to remain resilient. Higher interest rates have not had a material impact on the overall economy yet. Growth remains above trend and the labor market remains tight. We will continue to monitor the health of the real economy, because in the end, this is what truly drives value in the stock market.
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.
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.