iSectors Post-MPT Growth Allocation: Messaging Notes for 2nd Quarter, 2018

Posted on: 04/12/2018

  1. The Post-MPT model became more conservatively positioned over the past quarter.
    • The largest allocation increase has been US Treasury Bonds.
    • Financial and technology stocks have seen the largest allocation decrease.
    • Leveraged positioning in Post-MPT Growth has decreased from 32% to 9% (33% is the maximum allowed).
    • Besides US Treasuries, the strategy is significantly overweighted in financials, real estate, and utilities.
    • Technology, materials, and health care are underweighted.


  1. The model indicates that the U.S. economy should continue to grow in 2018 but at a slower pace than in 2017.
    • The model is no longer fully invested in stocks due to its significant allocation to bonds
    • According to the business cycle approach to equity sector investing, the reduction in technology and financial stock holdings and overweights in real estate and utilities indicates a move from the mid-cycle to late-cycle in the economy. As we have been expecting, technology has been the best performer over the past five years as corporations and individuals reversed the underinvestment in technology that took place during and in the aftermath of the Great Recession. As is usually the case in the mid-cycle, utilities and materials have underperformed over the past five years.
    • If we are going into the late-cycle, we should expect materials, health care, real estate, energy and utilities to post the strongest results. The model has already significantly overweighted real estate and utilities and has a slight overweight in energy.
    • The Post-MPT model strongly overweighted materials at the end of the 2002 – 2007 economic expansion. Along with energy, materials have done well historically in the late-cycle as inflationary pressures build and the late-cycle economic expansion helps maintain solid demand. The combination of strong increases in energy demand and a slowdown in Chinese growth may be leading our indicators to favor energy over materials.
    • Health care may have already seen its best days. Although tied to basic needs, which would usually attract investors looking for stocks that are less economically sensitive in this part of the cycle, health care was a leading sector in 2012 to 2015 due to the continued rollout of the Affordable Care Act (ACA), the Federal Drug Administration speeding up its drug approval timeline, and companies strongly raising prices. All of this took place as the population aged and needed more drugs and services. But given the continued attacks on ACA and Medicare reimbursement rates, health care sector revenue growth is likely to slow in the coming years.


  1. The model is allocating significantly to Treasury Bonds against the consensus view.
    • The 10-year Treasury yield is in the high end of the 12-month 2.00% – 3.00% range.
    • The bond market will question the wisdom of significant decreases in the Federal Reserve balance sheet while increasing Fed Fund rates in a time of moderate to weakening inflation. Retail sales have declined for three consecutive months and the lack of significant increases in paychecks due to the tax cut may keep purchase growth tepid. Core Personal Consumption Expenditures Price Index is the key measure of inflation for the Federal Reserve. This measure has remained far below their 2.0% target at 1.6% for the latest reading.
    • Both the Fed and the market are predicting two more 25 basis point rises in the Fed Fund rate in 2018. Given the slow growing economy, the lack of inflation pressure and the additional drag from the balance sheet decreases, we believe there is a risk that there may be only one additional increase this year.
    • The combination of slow economic growth, modest inflation and a less aggressive Fed will lead to declines in 10-year yields back to the 2.25% to 2.50% area in the coming months benefiting dividend stocks including utilities and real estate.


  1. The overweighted equity sectors will have strong, certain demand in 2018.
    • Financials (FNCL and FAS) performed in line with the market during the first quarter. Fed rate hikes and strong loan demand are pushing up revenue growth. Also, regulatory reform is resulting in increased dividend payments and share buybacks that will attract investors in the coming quarters.
    • Utilities (VPU) underperformed in the quarter due to rising interest rates. With real estate and Treasury bond holdings, interest sensitive stocks are over 60% of the model’s risk, currently. There continues to be a never-ending demand for yield that will shield sector returns in a market correction. In March, utilities (and real estate) earned positive returns as the broad market declined. If our economic and broad market forecasts are realized, the combination of high yields (averaging 3.3%) and rising dividend rates will cause utility stocks to outperform in 2018.
    • After opening the year with poor performance, real estate (VNQ) was the best sector in March. Continued low interest rates and a growing economy have increased demand for commercial real estate assets. Since financing for new projects has been difficult to obtain, rents increases have been strong, especially in the apartment and office markets. On the other hand, there is risk in the retail area with the move to online shopping. Much of that risk has been discounted in those securities already. With dividend yields of close to 5% and lower tax rates on those dividends, real estate is an attractive sector.

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