- The recent U.S. stock market decline is not unusual. However, it has been two years since one of this magnitude has happened.
- In a typical year, a 11% to 14% drop in the Standard & Poor’s’ 500 is likely.
- Expectation for rising stock prices had climbed to the highest level in over 25 years!
- The difference between the 10-year Treasury yield and the 10-year Treasury Inflation Protection Securities (TIPS) yield is known as the 10-year breakeven inflation rate. The recent rise in the breakeven rate indicates that market participants are becoming more worried about inflation. But notice that the breakeven rates are not back to the highs seen at the beginning of the decade. Stocks are probably overreacting to higher inflation at this point.
- With expected earnings growth of 15% to 20% expected this year, the market is most concerned that higher inflation will lower price/earnings (P/E) ratios and therefore stock prices. As the graph below indicates, there is some deterioration historically in P/E ratios as inflation climbs over 2%. But significant damage to equity P/Es does not take place until (expected) inflation rises over 4%.
- But advisors need to be cautious since we are in the unusual position of rising interest rates and falling stock prices. We believe that interest rates will fall since some of the recent inflation indicators (such as average hourly earnings) may be overstated due to fourth quarter 2017 weather-related phenomena and seasonal adjustments. If we are wrong and the current scenario is analogous to 2000, we may be in for a bumpy ride in the equity market ahead.
- In any case, we recommend that advisors take 10% from equities and 5% from fixed income and invest the proceeds in the iSectors® Post-MPT Growth Allocation as a liquid alternative in client portfolios. The strategy is fully invested with an overweight in defensive, late-cycle sectors including energy, financials, and utilities. It also has a significant position in Treasury Bonds.
Below is presented the 18 rolling three-month periods of the Standard & Poor’s 500 Index Total Return’s negative returns and the corresponding Post-MPT Growth Allocation’s performance for time frames after the 2007 – 2009 bear market (the bear market comparisons would be too easy for Post-MPT Growth; it outperformed the S&P 500 by almost 21 percentage points in 2008).
For comparability, all returns are gross of fees.Although no strategy will perfectly outperform the benchmark and past performance may not indicate future returns, Post-MPT Growth was superior to the S&P 500 in eleven of the eighteen periods for an average difference of 3.18% and a median difference of 1.07%. In fact, Post-MPT Growth* had positive returns in 39% of these timeframes when the S&P 500 was negative!
If you are a financial advisor that wants to learn more on how to protect client assets in market declines, please contact Scott Jones at 800-869-5184 or [email protected]. Alternatively, you may wish to register on our website www.isectors.com to review information on the Post-MPT Allocations.
*Note: The iSectors Post-MPT Growth Allocation is also available as an exchange traded fund (ETF). For more information, visit http://isectors.com/isectors-etfs/.
Individual investors can contact Scott Jones for a referral to a recommended iSectors advisor that can help you determine the best iSectors asset allocation for their portfolios.