iSectors®Post-MPT Growth Messaging Notes for 4Q 2017

Posted on: 10/03/2017

  • The U.S. economy is growing, but at a slow pace, as evidenced by the 2.1% annualized real GDP print for 1H 2017.
    • 3rd Quarter growth will see a rise to the 2.5% to 3.0% annualized rate due to strength in manufacturing. Upcoming numbers will be difficult to interpret given the impact of recent hurricanes
    • However, we are concerned about the retail picture going into the all-important holiday season. August retail sales declined the most in six months. Five of the seven months since February have had flat or declining sales from the previous month. Although September auto sales rose due to hurricane-related buying, the trend for the year has been lower compared to 2016. Consumer sentiment is strong, but it has not translated into retail spending.
    • Housing sales continue to weaken. Pending home sales have dropped every month this year except one. New home inventories will continue to decline given the labor that will migrate to Texas and Florida in the coming months.
    • We expect, in the near to intermediate future, that consumer spending is the major engine pumping up the economy. We do not expect any significant congressional action to help the economy by year-end. In fact, the Atlanta Federal Reserve GDPNow 3Q forecast has fallen from 4.0% to 2.7% and may go lower when September numbers are posted.
    • Although the August consumer price index accelerated, it was mainly caused by higher gasoline prices in the wake of Hurricane Harvey. Not including food and energy, the year-over-year increase was 1.7% the same as in previous months. Slow progress in economic growth will keep inflation in check in the coming quarters. Personal Consumption Expenditure price index increases (the Federal Reserve’s preferred measure) have moderated to 1.3% over the past year and should stay under the 2.0% target into 2018.
  • The bond market has become too concerned about upcoming Fed rate increases
    • The 10-year Treasury yield is at the top end of the recent 2.00% – 2.45% 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. If the Administration is not able to push their tax and regulatory agenda through Congress, the market may decrease the U.S. economy’s growth prospects.
    • Both the Fed and the market are indicating one more price increase in December. Given the slow growing economy, the lack of inflation pressure and the additional drag from the balance sheet decreases, there will be no Fed rate increases in 2018’s first half.
    • The combination of slow economic growth, modest inflation and a less aggressive Fed will lead to declines in 10-year yields back to the 2.00% to 2.25% area in the coming months benefiting dividend stocks including utilities.
  • Although earnings are fine, rich valuations due to overly optimistic economic outlooks will keep stock market strength modest.
    • The Post-MPT model continues to be fully invested in stocks.
    • Earnings have accelerated throughout a wide range of market sectors.
    • Valuations have, however, become stretched. Although the S&P 500 12-month trailing P/E of 24 can be justified by 2% 10-year Treasury yields, there is not much room for further expansion.
    • Going into 2018, investors will be focused on sectors with
      • a) the prospects for increased dividends or buybacks in case there is a correction,
      • b) revenue growth from accelerating international economies, and
      • c) beneficiaries of regulatory reform happening behind the scenes.
    • Utilities (VPU and UPW) have become the highest weighting in the Post-MPT Growth model. With real estate and the recently initiated Treasury bond holdings, interest sensitive stocks are over one-third 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. 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.
    • Financials (FNCL and FAS) had a difficult third quarter. but interest rate movements and asset prices 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.
    • Year-to-date, technology (FTEC) was the best performing sector. We are over-weighted this sector. There is bipartisan support for tax-friendly, cash repatriation that would benefit the sector significantly. We are seeing a positive revenue trend from the reversing of long-term under-investment in this sector’s products by businesses and consumers.

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