Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, August 5, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Utilities Sector Review

Not all businesses are created equal. Businesses in some industries and sectors have exhibited more consistent earnings power because of the intrinsic pricing power and entry barrier (moat) in these sectors. Previously, we have analyzed consumer staples and health care sectors, in addition to S&P 500 companies as a business: 

We have shown that companies in consumer staples and health care sectors have more stable business that is translated to their steady stock returns. In this newsletter, we will continue to look at another sector, utilities, which has similar characteristics. 

Utility companies include water, gas, electric alternative energy and other infrastructure firms. Their industries are usually regulated: for example, an electricity company cannot arbitrarily raise its price. As these companies are usually involved with big up front infrastructure that are for our daily life, the entry barrier is very high (imagine how hard it is to start a new gas utility company from scratch). Since these businesses are more or less like regular toll collection, they enjoy more steady income and thus pay higher dividends to their shareholders on average. Furthermore, they can pass on inflation cost (such as commodity cost) to consumers, thus they also offer inflation protection. Utility stocks are perceived to be between average/growth stocks and bonds. 

Competitive returns

First, let’s look at utility stocks returns, compared with S&P: 

Utility vs. S&P 500 (as 7/1/2019):
Fund 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR Since 6/18/85
VFINX (Vanguard 500 Index Investor) 10.4% 15.2% 10.6% 14.5% 8.8% 10.3%
FSUTX (Fidelity Select Utilities Portfolio) 13.8% 11.8% 8.5% 13.0% 10.1% 10.1%
XLU (Utilities Select Sector SPDR ETF) 17.8% 8.7% 10.0% 12.0% 10.3% N/A

*: NOT annualized

Notice that unlike XLUFSUTX (Fidelity Select Utilities Portfolio) may consist of stocks not in S&P 500 index. The reason we use FSUTX is that this is one of the oldest mutual funds in utility sector. With it, we can study the data up to 34 years (since 1985). 

From the above table, we can conclude that utility stocks have similar long term returns, compared with S&P 500. For the past 15 years, they have done better than S&P 500. On the other hand, they usually exhibit less fluctuation: XLU’s standard deviation in the past 15 years is 15.7 vs. S&P 500 (VFINX)’s 17.6. 

More stable earnings

Similar to health care and consumer staples stocks, utility companies exhibit more stable earnings growth. The following charts compare S&P 500 utility sector earnings with S&P 500: 

We need to point out that utility stock earnings are less smooth than both health care and consumer staples. For more details, please refer to previous newsletters. 

Better momentum

It’s interesting to investigate whether utility stocks exhibit better momentum than S&P 500. To do so, we construct P SMA 200d FSUTX FSUTX ABNDX As Cash Monthly that uses FSUTX’s 200 day SMA (Simple Moving Average) as a momentum signal. When FSUTX’s total return (i.e. dividend reinvested) line is above its 200 day SMA, the portfolio holds FSUTX, otherwise, it holds ABNDX (American Funds Bond Fund of Amer A). Again, the reason to use ABNDX is because of its long history. Both Vanguard total bond index fund VBMFX and our total return bond portfolio like have shorter history. 

Portfolio Performance Comparison (as of 7/1/2019):
Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR Since 7/1/86
P SMA 200d VFINX VFINX ABNDX As Cash Monthly 2.5% -6.0% 8.1% 6.2% 12.0% 9.6% 10.3%
P SMA 200d FSUTX FSUTX ABNDX As Cash Monthly 12.8% 13.3% 7.0% 6.4% 11.3% 10.6% 11.6%
VFINX (Vanguard 500 Index Investor) 19.4% 11.1% 14.3% 10.6% 14.5% 8.8% 9.8%
FSUTX (Fidelity Select Utilities Portfolio) 12.8% 13.3% 10.7% 8.5% 12.8% 10.1% 9.4%

Surprisingly, not only this portfolio is much better than FSUTX itself, it actually does quite better than S&P 500 (VFINX)’s own timing portfolio P SMA 200d VFINX VFINX ABNDX As Cash Monthly: 11.6% annualized return vs. 10.3%. This clearly indicates that utility stocks have better momentum property. 

The above studies also allude to some evidence for a widely held belief: utility stocks are leading indicator for general stock market. We will discuss this topic in more details in a future newsletter.  

To summarize, utility stocks offer comparable long term returns (to S&P 500) and lower volatility. Furthermore, stocks in this sector exhibit better momentum that can be exploited to derive better returns with slightly lower maximum drawdown. 

Market overview

Stock market euphoria continued last week: with anticipation as well as confirmation, the trade war with China is now temporarily on hold again. As a result, S&P 500 continued its record run. In addition, bonds and gold are strong, indicating expectation of lower interest rate as well as US dollar weakness. Unfortunately, near term fundamentals are not as rosy as markets show: in addition to the expected negative Q2 earnings growth, analysts now expect negative Q3 earnings growth as well. Nevertheless, investors simply ignore the bad news. Again, our position is to stay the course at a comfortable risk level. 

For more detailed asset trend scores, please refer to 360° Market Overview

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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