2020 | January Risk Odometer
FCWS View January 2020 | Outlook: Positive
Happy New Year to all our readers! I hope everyone had an enjoyable holiday season. In terms of the markets, 2019 could not have been more different from 2018, as almost every asset class experienced positive returns. Trade war headlines dominated the news in 2019, but the Federal Reserve’s three rate cuts were the dominant force behind the stock market rally. Even the bond market participated with outsized gains. It was truly a remarkable year.
We are starting 2020 where we left off 2019 with a “Positive” Outlook. Our actual Risk Odometer net score, though, has moved two notches lower to +2. Our Earnings indicator turned from bullish to bearish (from green to red) causing the change in the overall score. Despite the lower net score, the price action of the market has been far too strong to warrant an official change to our outlook.
The consensus outlook for the economy is for growth to pick up in 2020. The year ended with the trade war taking a positive turn and markets cheered this with strong 4th quarter gains. Never mind the sluggish growth, deteriorating leading economic indicators and lack of earnings growth in 2019. The market is convinced 2019 was a “mid-cycle slowdown” as the Fed claimed it was. The strong consensus outlook for continued growth is why the market did so well in 2019. I do believe this poses some risk.
The technical price action of the market is telling me that the deteriorating fundamental indicators should reverse in 2020. The backdrop of an improvement on the trade front, low inflation, and a continued strong labor market is keeping investors optimistic about the future. I also believe Trump will do whatever is reasonably possible to keep the stock market elevated. He uses it as a scorekeeper of his political policies and the last thing he needs before an election is to lose ground on that front.
While I am overall positive for now, I think it will be very difficult for the market to reproduce gains seen in 2019. I say this because the gains from 2019 appear to be based on very optimistic future growth. When the stock market rallies 30% but earnings do not grow, it creates high expectations for the future. This does not mean the market will trade lower, but it does require expectations to be met first. I believe the high expectations will make gains more challenging and the market vulnerable to downside surprises, yet, I think the will of the administration to keep the markets happy in 2020 will outweigh the risks. For this reason, I am expecting underwhelming and below-average gains in 2020 but gains nonetheless.
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.