Feb 20: Risk-off Markets

By Jeffrey Cohen, President, US Advanced Computing Infrastructure, Inc.
Chicago Quantum
Highland Park, Illinois 60035
Financial planning, investment management, and portfolio optimization services

Today we made a youtube livestream video and discuss that we see the US stock market as risk-off. We discuss how we come to this conclusion, and what it might mean to you as an investor.

Risk-off markets means that the expected returns to investing in risk is lower, and the expected return in investing in risk-free assets is higher than it was before, and the difference is too small for many to take that risk.

The expected return to risk in our quantitative models is just under 4%. Would you risk your wealth for a 4% per year expected return? Would you rather buy a US savings bond, put money in an FDIC insured savings account, or invest in short-term (4 week, 13 week or 52 week US Treasury bills)? Every time the risk free rate of return rises (it is now 4.70%) and the expected return of the stock market falls (now 8.57%), it lowers the expected return to taking risk (now 3.87%).

Given the new inflation readings this past week (CPI and PPI both up dramatically), many investors expect the US Federal Reserve Bank to raise policy interest rates again, and further tighten the money supply (which keeps rates high by making money harder to borrow).

The stock market is in a bear market, with the trend decidedly negative, although the past few weeks have seen the market rally above a straight line we drew on a chart to highlight that downward trend. It is possible the market drops down to that line...and follows the pattern of the past six months. We believe the market will trend lower for a few months while interest rates continue to rise and the economy continues to cool, before there is a chance of a market recovery.

Interest Rates are rising over the past year.

The stock market is in a committed downturn, but has risen significantly in the past 2 months. If the market resumes its trend, it is expected to go lower.

Our model has a simple suggestion for investors. If you must invest in US equities, whether due to a core belief, your investment objectives, or just what you think is right, then you should invest in a large number of stocks and diversify your positions. The typical stock in your portfolio should be lower risk than before. These could be stocks in defense contractors, pharmaceuticals, consumer products, food, large technology firms, or dividend-paying 'safe bets.' 

On February 18, 2023, we ran our Chicago Quantum Net Score model to see what the most optimized long portfolio was that we could buy and hold. This portfolio would provide the best risk-return tradeoff from buying US Common Stocks. It picked 49 stocks, held evenly. This portfolio gives the investor a relatively small edge over holding all stocks evenly, about 5.4 x 10-5, when the value of the CQNS index for all stocks is zero. (actually 12.7 x 10-19, but who's counting)

Here is the optimized US common stock portfolio, held evenly (so each position is kept at a market value of ~2% of the total portfolio):
['AB', 'ABBV', 'ACI', 'AFG', 'AON', 'ATVI', 'AVGO', 'AVTA', 'BLX', 'BSM', 'CFFN', 'CL', 'COWN', 'DSGX', 'ELME', 'EQC', 'EWCZ', 'FROG', 'FTDR', 'GCMG', 'GEN', 'GOOG', 'GOOGL', 'ICL', 'IEP', 'JNJ', 'K', 'LHCG', 'LLY', 'LMT', 'MCD', 'MGI', 'MRK', 'PCAR', 'PEAK', 'PEP', 'PNM', 'RBA', 'RFP', 'RGR', 'SBLK', 'TGNA', 'TJX', 'TRI', 'TSEM', 'TXN', 'WY', 'ZGN', 'ZIM'] 49

We also looked at some proprietary indices we created to track segments of the market. Here is how three of them did on Friday, February 17, 2023:

• High-BETA stocks: These are very high risk stocks. They dropped more than an equity index.
• Chips and Semiconductor stocks: These are higher risk stocks. They dropped more than the index.
• Platykurtic & Low Variance: These are extremely low risk stocks. They rose when the index fell.
• Leptokurtic & Low Variance: They are also extremely low risk stocks, but with a higher chance of a big surprise. They also rose when the index fell.

This tells us that the market is rotating out of high risk stocks and into low risk stocks. Wish you would have know that two weeks ago? Is it too late to act now?

We have been calling the market as RISK-OFF in our youtube videos since February 8, 2023, or two weeks ago. This is the link to our youtube channel, which is free. Our YouTube handle is IamJeffreyCohen.

Good luck to everyone in the markets. Stay safe.
Jeffrey Cohen

​One more point. We notice that our model is picking stocks that pay dividends. Almost all of the top 20 stocks had a positive dividend yield in the past year. This makes sense to us that stocks with dividends have lower risk.

We would caution investors against buying a stock only because it pays a dividend. There should be other justifications, such as the business model of the firm, economic outlook, effectiveness of management, etc. 

As interest rates rise, the value of those dividends falls in today's US Dollars. (in technical jargon, the net present value of those dividends is lower when your cost of capital rises)