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The purpose of this brief is to provide a summary of the tactical model portfolio allocation updates we are making for 2018.
Executive Summary:
US and International GDP growth has shown recent momentum. The Atlanta fed GDPNow forecast for Q4 as of December 22th was 2.8% [Atlanta Federal Reserve Bank].
US PE multiples expanded this year roughly 10% and price to prospective earnings now stands at 21.6% compared to 19% this time last year [Morningstar].
Inflation has remained low and macro indicators are not showing any evidence of significant increases coming. Still, concern is growing. Recent strength in the producer price index (PPI) and productivity may put upward pressure on inflation. Wage inflation will likely be the canary in the coal mine.
International Developed Country and Emerging Market PE ratios are now relatively more attractive compared to one year ago. Furthermore, likely dollar weakness and converging GDP growth expectations in Europe help the case for increasing allocations to international equities [JP Morgan, Doubleline, GMO].
We are increasing our allocation to international developed to 16%. We are increasing our allocation to emerging market to 16%, up from 10%. (Allocations are relative to equity weighting. For example, international weighting in the Brightwood Balanced 50 would be 8% each for developed and emerging funds.)
Modest interest rate increases continue with the Fed expected to raise rates 4 times in 2018. We are positioned for less duration risk with model portfolio average duration of 3.92 vs. the 8.2 for the US aggregate bond market index [Morningstar]. Our 2017 portfolios provided positive alpha for bond allocations and funds. We will continue with our current funds and allocation mix with 40-60% active bond funds, 5% in emerging market sovereign bonds and the balance in the passive US aggregate bond index funds.
Our US equity allocation moves from 80% to 68% as we increase international weighting. Our US quality allocation increases to 30%. Quality factor portfolios are expected to hold up better in down markets, and given valuations, we think holding a portion in quality is prudent.
We will increase our exposure to technology by taking a 12% overweight. The valuations are attractive and the long term growth prospects are compelling.
We will increase our healthcare sector weighting to 12% overweight based on positive earnings growth projections [S&P 500, Morningstar] and diversification benefits to combining healthcare and technology [Brightwood Ventures analysis].
We continue to seek out the very best low-cost funds to implement the passive components to the strategy. For active funds, we continue to evaluate the alpha generated for paying fees over passive index fund equivalent rates. For example, our Brightwood 50 Balanced portfolio weighted average fund fees will drop to .23%, down from .26%. Additional details on the implementation of funds can be found in our Morningstar model portfolio snapshot reports.
Please feel free to call me or email if you have questions or if you would like to receive details on specific models, including model fund holdings and allocation percentages.
Happy New Year!
sources:
Federal Reserve Bank of Atlanta. “Latest forecast: 2.8 percent — December 22, 2017”. Accessed December 26, 2017.
< https://www.frbatlanta.org/cqer/research/gdpnow.aspx>
GMO LLC. “7‐Year Asset Class Real Return Forecasts”. October 31 2017. Accesses December 7, 2017.
< https://www.gmo.com/north-america/welcome>
JP Morgan. “2018 Capital Market Assumptions”. JP Morgan Asset Management. November 28, 2017.
Morningstar, Inc. Advisor Workstation. 2017.
Doubleline Funds. “So Far, So Good”. Jeffrey Gundlach. December 5, 2017. https://doublelinefunds.com/webcasts/
S&P Dow Joines. “S&P 500 EARNINGS AND ESTIMATE REPORT.” Howard Silverblatt. November 30, 2017.
<https://www.google.com/search?q=s%26p500+earnings+setor+xls&oq=s%26p500+earnings+setor+xls&aqs=chrome..69i57.10351j0j7&sourceid=chrome&ie=UTF-8>