FCWS VIEW APRIL 2021 | OUTLOOK: POSITIVE
Our Risk Odometer moved one point higher this month to +2 and our Current Outlook also increased to “Positive”, its most optimistic level in its four-level outlook status. Our Risk Odometer is now at the highest level since prior to the pandemic, and we are expecting it to continue to improve over the next several months as the economy continues to improve. Unless something suddenly derails the economy, we could see our Odometer surge to +5 by the middle of the year. This month’s rise, and our expectations for further increases, is increasing our confidence in positive future stock market returns.
The improvement in our outlook is centered around the Federal Reserve’s commitment to maintaining their record accommodative policy despite recent economic improvements. This unusual commitment to maintain record monetary stimulus, coupled with record fiscal stimulus from the federal government, is creating a record two-pronged amount of stimulus that is keeping investors extremely optimistic.
Neither of these sources appears to be fading. The Federal Reserve has been consistent in their message that they will not remove accommodation until inflation is sustainably above their target, and the federal government is now introducing a $2 trillion infrastructure bill after recently passing their $1.9 trillion stimulus bill in the first quarter. Never has the market seen this amount of stimulus for this length of time!
This record amount of stimulus, maintained for a record length of time, has driven the VIX Index to the lowest level since prior to the pandemic, triggering another positive signal for us. We expect Leading Economic Indicators and Earnings to also turn positive over the next several months. This could put our Risk Odometer to +5 in the months to come, by far the highest reading in a long time. This should keep our outlook positive for the foreseeable future.
The biggest risk in the near-term is overly optimistic sentiment. Extremely bullish sentiment coupled with record valuations can lead to significant market corrections.
Future tax increases are another area of concern. Tax increases is just now being discussed with the introduction of the infrastructure plan. Lower tax rates were, in our opinion, the biggest reason why markets were surging prior to the onset of the pandemic. Significant changes could derail the positive sentiment which is keeping markets elevated.
The last major risk we see is a sustained (not transitory) rise in inflation. A sustained rise would change Fed policy, and this would certainly disrupt market gains. Chairman Powell has been consistent in his communication that he believes the economy will experience a surge higher in inflation over the next several months, but that surge would be transitory and technical in nature (base effects of year-over-year calculations) and not a sustainable rise in inflation. Since the surge of inflation has yet to occur, it would take some time for it to be considered transitory or sustainable, therefore we do not view this as a near-term risk. Sustainable inflation would be a game changer for the markets, though, so we will be watching it closely over the next 6-12 months.
Risks are always prevalent, but bull markets climb walls of worry. Given the increase in our Risk Odometer and expected future increases, we would view any future volatility as opportunistic at this stage. The only thing could derail that is a sudden surge in Covid that vaccines would not protect against or an unexpected change in policy by the Federal Reserve, neither we see as likely. For this reason, we remain optimistic.
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.