2025 Investment Road Signsᵀᴹ Outlook
At Compass Wealth Management, we have developed a set of comprehensive economic and policy indicators called Investment Road Signsᵀᴹ that serve as guidance for our proprietary investment risk management system. These indicators help us determine whether we are currently on an Investment Highwayᵀᴹ or facing an Investment Detour Strategyᵀᴹ.
So, what are our Investment Road Signsᵀᴹ telling us at this moment? Right now, we believe three key signs are present which represents an elevated level of risk in the capital markets.
Fed Policy
Fed policy is our first Investment Road Signᵀᴹ and the one we consider the most pivotal. The chart above illustrates the Fed’s funds rate policy, which projects a steady decline in rates starting this year (shown in the blue dotted line in the graph above). Here’s what we’re observing:
The market (shown as green dotted line) is anticipating that the Fed will significantly slow its rate-decreasing campaign this year.
The Fed has yet to fully align its policy with these market expectations. The concern is that if and when the Fed does reflect this in its actions, it could result in restrictive policy measures that were not anticipated—potentially creating a greater level of risk in the market.
Market Valuation
Our second Investment Road Signᵀᴹ is market valuation, where we analyze the price-to-earnings ratio (commonly called a P/E ratio) of the S&P 500 and its top ten stocks:
The orange box at the top of the chart highlights an elevated P/E ratio for the S&P 500, which is approximately 30% higher than its long-term average.
Additionally, the top ten stocks within the index have an even higher—and recently rising—P/E ratio, sitting about 1/3 higher than the current lofty P/E ratio of the overall market. This confirms that the market valuation road sign is clearly present!
Unemployment
The last Investment Road Signᵀᴹ to cover is unemployment. Historically, whenever the unemployment rate has increased by +0.6% from the lowest point of the business cycle (as seen in the green box in the chart above), it has usually indicated a recession. These unemployment increases of +0.6% from the cycle lows have preceded or coincided with each of the last twelve recessions (represented by the grey vertical bars), with only one false signal in 1959.
This reading is now +0.8% higher than the lowest point of the cycle, which is clearly above the +0.6% cycle low indicating a recessionary period may be imminent.
Summary
As we move into 2025, a Fed policy road sign sighting is becoming more likely, and clear road signs are present for both market valuations and unemployment. These road signs guide our risk mitigation strategy, allowing us to take action without relying on timing the market. Key steps include overweighting value sectors to reduce exposure to the top ten overvalued stocks in the S&P 500, adding equity hedging strategies to portfolios, and incorporating alternative assets like gold. These strategies have helped enhance risk reduction across many client portfolios, especially those with larger equity allocations, positioning us to navigate elevated market risks with greater stability.
Have questions or want to speak with our team directly? Contact us.
Robert Amato, CFP®, CIMA®
Principal
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Compass Wealth Management is a Registered Investment Advisor. Advisory services are only offered to clients or prospective clients where Compass Wealth Management and its representatives are properly licensed or exempt from licensure. This article is solely for informational purposes and is not intended to be relied on as a forecast, research, or investment advice, and is not a recommendation, offer, or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Compass Wealth Management to be reliable, are not necessarily all-inclusive, and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investments involve risks.