Monday Morning Minute 100917
THE WEEK AHEAD
We update our input tables to our long-run forecast and tactical top-down investment process.
MACROECONOMIC INSIGHT
Each quarter, we update a series of tables that lie behind our long run tactical asset allocation decisions. These are all forward-looking assumptions and are inherently imperfect estimates of the future. Still, these base-case assumptions are necessary and important inputs that form the basis for our top down investment process. The ratcheting down of our WCA Fundamental Conditions Barometer (currently near 50 vs. 75 at the start of the year), faster than expected rate increases, stubbornly low inflation, improving overseas trends, and fading of expectations for a large increase in the fiscal deficit lead us to make the following adjustments to our long-run macro forecast assumptions.
Adjustments:
1) Trimmed the long-run U.S. growth assumption to 2.25% from 2.75% at the start of the year
2) Now assuming less steepening of the yield curve
3) Lifted the expected contribution to corporate growth from overseas
These changes, along with market movements since year-end, lead us to trim our long-run equity return assumption to just below 5%, and slightly increase our long-run Treasury bond return assumption to 2.6%. The tables below reflect our newly updated “base case” assumptions.
As a result of changing inputs, tactical adjustments were made during August. Equity exposure was cut to neutral and fixed income was increased to neutral in the short-term tactical satellite portion of Conquest portfolios. Exposure to credit was trimmed back to neutral from overweight, and duration was increased to neutral from underweight within the core part of Conquest portfolios. The “satellite” is comprised of a 20% allocation focused on shorter-term changes in the outlook. The “core” is comprised of an 80% portfolio weight and focuses on long-term risk adjusted return assumptions by sub-asset class.
ASSUMPTION TABLES
| WCA U.S. Growth Assumptions | |
| Assumed Real U.S. Growth During Expansion | 3.0% |
| Assumed Real U.S. Growth During Contractions | -2.0% |
| 1-Year Recession Probability (Typical) | 15% |
| 1-Year Recession Probability (Current Assumption) * | 15% |
| 5-Year Recession Probability (Current Assumption) * | 56% |
| 10-Year Recession Probability (Current Assumption) * | 80% |
| Latest WCA Fundamental Conditions Barometer Reading | 50 |
| WCA 10-Year U.S. Growth Assumption* | 2.2% |
| * Given most recent WCA Fundamental Conditions Barometer reading |
| WCA Long Run Global Growth Assumption | |
| World (Non-U.S.) | 3.4% |
| United States | 2.2% |
| Estimated Percent U.S. Profits from Overseas | 30% |
| Blended Growth | 2.6% |
| WCA Valuation Inputs | |
| Current S&P 500 Forward Earnings Multiple | 17.8 |
| 10-Year Average S&P 500 Forward Earnings Multiple | 14.2 |
| % Difference | 25% |
| Current S&P 500 Profit Margin | 11.1 |
| 10-Year Average S&P 500 Profit Margin | 10.1 |
| % Difference | 10% |
| Source: FactSet |
| WCA Cash Return Assumptions | |
| Current Short-Rate | 1.16% |
| Average Return Over Transitional Period | 1.83% |
| Terminal Value Assumption | 2.50% |
| Expected 10-Year Cash Return | 2.17% |
| Expected Annual Volatility | 1.00% |
| WCA Fixed Income Return Assumptions | |
| Required Returns | |
| Real Risk Free Rate (r*) | 0.75% |
| Inflation Premium | 1.75% |
| U.S. T-Bill Rate | 2.50% |
| Maturity Premium | 1.00% |
| 30yr U.S. Treasury Rqd Return *** | 3.50% |
| Annual Valuation Adjustment | -0.95% |
| 30-yr U.S. Treasury Expected Long-Run Return | 2.6% |
| Annual Volatility Assumption | 11.4% |
| WCA Long-Run Equity Return Assumptions | |
| Real Domestic Economic Growth | 2.20% |
| Excess Corporate Growth from Overseas | 0.37% |
| Expected Domestic Inflation | 1.75% |
| Expected Dividend Contribution | 2.00% |
| Net Dividend Repurchases | 1.50% |
| Profit Margin Adjustment | -0.90% |
| Valuation Adjustment | -2.00% |
| Expected Equity Return | 4.91% |
| Expected Annual Volatility | 14.5% |
| Equity Risk Premium vs. Treasuries | 2.35% |
| These views are provided by Washington Crossing Advisors, LLC. Assumptions are estimates based on historic performance and an evaluation of the current market environment. These are estimates only and not intended to represent future performance. References to future expected returns and performance do not constitute a promise of performance for any asset class or investment strategy. Volatility refers to an expected standard deviation of returns, a measure of uncertainty around our estimate. The forecasts contained herein are for illustrative purposes only and not to be relied on as advice or interpreted as a recommendation to engage in the purchase or sale of any security or financial product. These forecasts are based upon subjective estimates and assumptions about circumstances and events that may not have taken place and may never do so. In addition, Washington Crossing used historic index returns in evaluating past return relationships. This information was gathered from third-party sources we deem reliable, but no independent verification has been undertaken. Actual returns could be higher or lower than shown herein. Opinion subject to change without notice. | |
ECONOMIC DATA THIS WEEK
| Date | Report | Period | Survey | Prior |
| Monday, Oct 9: | No Releases | |||
| Tuesday, Oct 10: | NFIB Small Business Survey | Sep | 105.0 | 105.3 |
| Wednesday, Oct 11: | FOMC Meeting Minutes | |||
| Thursday, Oct 12: | Producer Prices (Core) | Sep | 0.2% | 0.1% |
| Friday, Oct 13: | Consumer Prices (Core) | Sep | 0.2% | 0.2% |
| Retail Sales (Ex-Autos) | Sep | 0.9% | 0.2% | |
| Business Inventories | Aug | 0.6% | 0.2% | |
| Source: Bloomberg |
ASSET ALLOCATION PORTFOLIO POSTURE
Based on shorter-term expectations, the “tactical” allocation within portfolios is equally weighted between bonds and stocks.
Client approved reports and commentaries click here
Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Suzanne Ashley, Analyst
(973) 549-4052 www.washingtoncrossingadvisors.com www.stifel.com
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Disclosures
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
The information contained herein has been prepared from sources believed to be reliable but is not guaranteed by us and is not a complete summary or statement of all available data, nor is it considered an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. There is no guarantee that the figures or opinions forecasted in this report will be realized or achieved. Employees of Stifel, Nicolaus & Company, Incorporated or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within. Past performance is no guarantee of future results. Indices are unmanaged, and you cannot invest directly in an index.
Asset allocation and diversification do not ensure a profit and may not protect against loss. There are special considerations associated with international investing, including the risk of currency fluctuations and political and economic events. Investing in emerging markets may involve greater risk and volatility than investing in more developed countries. Due to their narrow focus, sector-based investments typically exhibit greater volatility. Small company stocks are typically more volatile and carry additional risks, since smaller companies generally are not as well established as larger companies. Property values can fall due to environmental, economic, or other reasons, and changes in interest rates can negatively impact the performance of real estate companies. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. High-yield bonds have greater credit risk than higher-quality bonds. The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
All investments involve risk, including loss of principal, and there is no guarantee that investment objectives will be met. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager. Equity investments are subject generally to market, market sector, market liquidity, issuer, and investment style risks, among other factors to varying degrees. Fixed Income investments are subject to market, market liquidity, issuer, investment style, interest rate, credit quality, and call risks, among other factors to varying degrees.
This commentary often expresses opinions about the direction of market, investment sector and other trends. The opinions should not be considered predictions of future results. The information contained in this report is based on sources believed to be reliable, but is not guaranteed and not necessarily complete.
Washington Crossing Advisors LLC is a wholly owned subsidiary and affiliated SEC Registered Investment Adviser of Stifel Financial Corp (NYSE: SF).
