The Week Ahead – Controlled Risk

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

During Winter Break, I brought my family up to Big Bear for our first family ski vacation. I had not skied in seventeen years (back when the Dow was 8,850 versus 29,000+ today). Despite being a fairly competent skier back then, I’m not afraid to admit I was a bit nervous that I had forgotten how to ski over my extended hiatus. With my five-year-old safely enrolled in ski school, I took to the chairlift. Sure enough, all trepidation fell away as I attempted my first turn – turns out skiing is just like riding a bike. But, I couldn’t help but feel a bit underwhelmed by the experience. The next run I selected was a significantly more demanding route that included a black diamond (expert) portion. This time, given the steeper run, I felt closer to my edge, and with that came a rush of adrenaline. This, along with the amazing vistas, fresh air, and ideal conditions is what all skiers crave.

Skiing, like all gravity sports, is all about controlled risk. The same can be said for investing. Without taking risk, investors should not expect returns above cash – also known as the risk-free rate. Today this is about 1.5%, which is not by coincidence roughly equal to if not slightly below that of inflation. Professional investment managers control risk using a concept known as modern portfolio theory (MPT). This Nobel Prize winning technique is based on the fact that diversified portfolios of uncorrelated investments result in superior expected returns for a given level of risk.

This week we will get one of our most robust high frequency indicators, the Leading Economic Index (LEI). The Leading Economic Index is an economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables. These variables have historically turned downward before a recession and upward before an expansion. The index was flat in November after being down three months in a row. Given the surging stock market, rebound in housing, and record breaking retail sales in December, we believe the LEI will move soundly into positive territory indicating a healthy economy going forward.

As a younger skier, I used to ski to the very limit of my abilities, which would occasionally lead to a nasty fall. This time, I stayed well within my skill level and managed to avoid any major mishaps. While it may not have been the most exciting way to go, it was plenty of fun. You see, older skiers like older investors don’t bounce back from a crash the way we once did.

Data deck for January 20–January 24: