Click here for this month's Risk Ratings.

US stock indices recently tested old highs and seem to be experiencing resistance. Small cap stocks, while showing some signs of life, are still well below their highs from three years ago. During election season, this is not surprising. International Stock Indices are getting back close to their 2021 highs. While valuations are high and the stock market keeps working, economic indicators continue to be a mixed bag. The ISM manufacturing index showed more weakness in July and August and remains in contraction territory where it’s been since early 2021. And while that gives us one data point, what really matters is results in the markets. And that’s why we stick with supply/demand and risk indicators for investments! The market tells a story. Our job is to listen.

Here are this month's highlights (which will sound very familiar):

• U.S. Stocks: Currently still in the green zone for risk. Our concern at this point is the continued narrowness of the markets. This means that a handful of stocks are causing the market indices to go up (that’s why it’s a good time to use index investments). For example, the Nasdaq currently has almost as many of its constituents at 1-year lows as it has that are at 1-year highs. At some point, it will become necessary to spread out the investments into less concentrated investments. But so far, that day is not today.

• Bonds: With the bond index yielding slightly less than 3.5% and short-term Treasuries yielding slightly more than 3.5%, it’s hard to get excited about high-quality bonds. If this weren’t an election year, I doubt we’d see a rate cut by the Fed in September (that’s not a partisan statement—it seems to occur under both parties). The question is: How much difference will a ¼% or ½% rate cut really make?

• International Stocks: Our signals are still green for international stocks, but the upside appears muted at this point. That is why we have largely substituted high-yield bonds (bonds that behave more like stocks) for international stocks.

• Real Estate: This asset class is suffering from low-dividend yields relative to the S&P and bonds. Commercial real estate (REITs) are still down from their 2021 highs but have recently been gaining steam.

We run our risk rating on the major asset classes as part of our investment discipline. We use traffic signals to indicate the level of risk (e.g., green is low, red is high). Each rating is calculated mathematically using an algorithm that considers the investment’s volatility relative to time, the trend direction, price movement, and price relative to highs and lows over several weeks.

State of the Market: Understanding the Risk Rating

Each month, we’ll show you what our math-based signals are telling us. For our Risk Rating, we use traffic light signals to indicate the level of risk (e.g., green is low, red is high). Each rating is calculated on how the investment performs relative to its high, low, and volatility relative to time.

Looking at the S&P 500 index since 1950, we have discovered key insights:

• Red Light Conditions:
  Red light conditions have existed only about 15% of the time since 1950. However, that 15% of the time accounted for only 1% of the gains of the stock market.
  99% of market return since 1950 occurred when the S&P was not in Red Light conditions.
  Virtually every major market correction (including 1987, 1989, 1998, the Dotcom Bust starting in 2000, and the Financial Crisis starting in 2008) occurred after conditions changed from Yellow Light to Red Light conditions.

We know that no indicator is perfect, past performance doesn’t mean Jack and no strategy guarantees a profit or prevention from loss. And we like having the risk rating to provide an edge in decision making. It helps us comply with our 3-Rules of Investing:

1. Have a Plan for Up Markets

2. Have a Plan for Down Markets

3. Have a Clear Way to Tell the Difference