FSI Sector Allocation - January 2024 Update

Please CLICK HERE to download the January sector allocation report in PDF format.

Welcome to 2024. First and foremost, I hope everyone had a delightful holiday season. Since the release of our December report, the market has clearly exhibited two distinct phases. Initially, from the beginning of December until the market high on December 28th, all sectors were on the rise, particularly led by Real Estate (+9.2%), Industrials (+7.1%), and Consumer Discretionary (+6.7%). Unfortunately, the market did not break through previous highs to create new records. The anticipated Santa rally did not materialize, and since December 28th, there has been a short-term market pullback. The entire sector leadership has reversed, with previously lagging sectors such as the defensive sectors—Energy, Utilities, and Consumer Staples—leading in the recent market consolidation.

With the arrival of the new year, we have made some adjustments to our Sector Allocation model. Broadly speaking, changes in sector weightings primarily stem from modifications to our strategic sector ratings.

Recall that our Head of Research, Thomas Lee, along with our Head of Technical Strategy, Mark Newton, released their latest 2024 year-ahead outlooks on December 7 and December 14, respectively. If you missed it, you can click on the corresponding links to watch the replays.

In addition to sector strategic ratings, we have made fine-tuning adjustments based on short-term sector momentum and updated our individual ETF recommendations.

Below is the summary of the January Sector Allocation result.

Sector ETF Allocation

Sector Strategic Rating

In the latest 2024 outlook, Thomas Lee and Mark Newton separately updated their sector ratings.

• Notably, Tom downgraded Communication Services from Overweight to Neutral, and upgraded Real Estate from Underweight to Overweight.
• while Mark upgraded Discretionary and Communication Services from Underweight to Neutral, and Energy from Neutral to Overweight.

Currently, for most sectors, Tom and Mark share similar views; for instance,

• Tom and Mark both Overweight Industrial, Tech, and Energy, maintain a Neutral stance on Materials and Communication Services, and have a negative outlook on Consumer Staples and Utilities.
• Regarding Discretionary, Financials, and Healthcare, Tom is Overweight while Mark remains Neutral.
• The only divergence lies in their perspectives on Real Estate, with Tom upgrading the sector from Underweight to Overweight, whereas Mark still maintains an Underweight position.

Let us now go through each of the 11 sectors.

Discretionary – Overweight (Lee) & Neutral (Newton):
The Consumer Discretionary sector is currently Overweight by Thomas Lee and has been upgraded from Underweight to Neutral by Mark Newton. Discretionary was one of the best-performing sectors in December, although it faced some pressure since the start of 2024. This is not surprising, as over 40% of the sector’s weight comes from AMZN -1.05%  and TSLA -2.04% . If the Fed turns dovish in 2024 and financial conditions ease, the Consumer Discretionary sector should benefit. This is one of the reasons Thomas Lee overweighted Discretionary. Technically speaking, despite recent momentum, Discretionary is still trending downward from 2021. Therefore, Mark Newton only upgraded it from Underweight to Neutral.

Industrials – Overweight (Lee) & Overweight (Newton):
Industrials is currently Overweight by both Thomas Lee and Mark Newton. From a macro perspective, Industrials has been among the top three sector recommendations in both 2023 (#3) and 2024 (#2). Notably, when PMI recovers, Industrials tend to perform well. Similar to the Discretionary sector, a dovish Fed or easing financial conditions could also benefit Industrials. Therefore, from a macro perspective, Industrials remains a top sector recommendation. Technically, the equal-weight Industrials experienced a significant rally relative to the S&P since 2022, reaching the highest levels in more than a decade. Despite some consolidation, Industrials remains a favorite sector in 2024.

Technology – Overweight (Lee) & Overweight (Newton):
Technology is currently Overweight by both Thomas Lee and Mark Newton. Technology led the market rally in 2023 and is expected to continue benefiting from tailwinds such as easing financial conditions, declining interest rates, and CapEx recovery. Although the ‘Magnificent 7’ (or broader Tech) might not be as strong as other areas such as small-caps, we still see upside in Tech. Technically, although equal-weight tech has reached highs unseen since 2020, and some consolidation is possible, Mark Newton believes we could see a breakout from this base, coinciding with a drop in interest rates.

Communication Services – Neutral (Lee) & Neutral (Newton):
Communication Services is rated Neutral by both Thomas Lee and Mark Newton. Benefiting from the broader tech rally, the internet constituents (especially those within FANG: META 0.09% , GOOGL -0.91% , NFLX -0.26% ) significantly aided the sector’s big rally in 2023, while the old telecom components remained flat. In 2024, Communication Services might not be as strong as last year, and the macro tailwinds could benefit sectors like small-caps and financials more. Hence, we downgraded Communication Services from Overweight to Neutral from a macro perspective.

Basic Materials – Neutral (Lee) & Neutral (Newton):
Basic Materials remains neutral by both Thomas Lee and Mark Newton, unchanged from the prior allocation.

Energy – Overweight (Lee) & Overweight (Newton):
Energy is Overweight by both Thomas Lee and Mark Newton. From a macro standpoint, the thesis has not really changed. Additionally, if Europe (and/or China) recovers in 2024, Energy could deliver better performance. From a technical perspective, Mark Newton believes the relative charts of energy are still quite constructive. Although crude might be choppy in the near term, it is likely to rise from January/February into September. This makes for great risk/reward for Energy.

Financials – Overweight (Lee) & Neutral (Newton):
Financials is currently Overweighted by Thomas Lee while Neutral by Mark Newton. Financials is Thomas Lee’s top pick for 2024 (along with Small-caps). Looking at the price chart, Financials have not fully recovered from the Global Financial Crisis. We think Financials in 2024 is similar to Energy in 2022 in many aspects, such as the bottoming of relative performance and being underowned by investors. Especially with a dovish Fed, easing financial conditions, and dropping mortgage rates, Financials could benefit from multiple macro tailwinds. Technically, Mark Newton has been Neutral on Financials. Admittedly, Financials made a good move off the lows, but further progress is required, especially after stripping out the leaders such as BRK/B, JPM 0.60% , BAC 0.34% .

Real Estate – Overweight (Lee) & Underweight (Newton):
Real Estate is currently Overweight by Thomas Lee but Underweight by Mark Newton. The upgrade of Real Estate by Thomas Lee is based on both short-term and long-term aspects. In the short term, if the Fed turns dovish, interest rates decline, and elevated mortgage rates normalize, the pent-up demand would be released, benefiting REITs. In the long term, the U.S. is facing a shortage of housing starts, and with millennials (and even Gen Z) starting to buy houses, the sector could benefit. Thus, we’ve made the largest change to our sector rating, upgrading Real Estate directly from Underweight to Overweight. Technically, Mark Newton’s “Underweight” rating is conceived from a “relative” perspective. He believes defensive sectors are likely unable to keep pace with other sectors and should be overweighted. Mark recognizes that if rates pull back dramatically, REITs could outperform briefly, but suspects a reversal in treasury in the latter half of the year.

Consumer Staples – Underweight (Lee) & Underweight (Newton):
Consumer Staples is Underweight by both Thomas Lee and Mark Newton. Generally, both Thomas Lee and Mark Newton see the defensive sector trailing the cyclical ones.

Healthcare – Overweight (Lee) & Neutral (Newton):
Healthcare is Overweight by Thomas Lee but Neutral by Mark Newton. Thomas Lee upgraded Healthcare to Overweight since late 2021, and it remains Overweight for 2024. Mark Newton remained Neutral on Healthcare in his 2024 outlook but noted in his January 3rd note that Healthcare has begun to show more evidence of strengthening. The breakout of Healthcare can be viewed as a necessary tailwind for upcoming market strength and part of the larger broadening out in the market since October. In his January 4th report, Mark Newton noted that Biotech appears favorable within healthcare, and in fact, Biotech is one of the five individual ETF picks in January 2024. More comments are below.

Utilities – Underweight (Lee) & Underweight (Newton):
Utilities is Underweight by both Thomas Lee and Mark Newton. However, Thomas Lee noted in his outlook call that Utilities could see an upside if interest rates fall. Given that Utilities is a small sector, we do not want our clients to pile into it, hence we keep Utilities as Underweight. From Mark Newton’s perspective, he recognizes that yields could appeal, especially in the first half of 2024. This would benefit Utilities, but relatively speaking, he anticipates a broader market rally in this falling rate environment. Therefore, defensive sectors should be underweighted. Within the Utilities sector, Mark Newton noted it is very important to be selective.

Momentum Adjustment
Recall that the final allocation of sector ETFs is composed of three parts: Index Mirror (50%), Sector Ratings (50%), and increasing the weight of the top 3 momentum sectors while lowering the bottom 3.

• Top 3 tactical sectors by using our momentum metrics are Financials, Communication Services, and Healthcare.

• Bottom 3 momentum sectors are Material, Consumer Staples, and Consumer Discretionary.

Individual ETF Picks

Since the December sector allocation update, our ETF picks as a group has slightly outperformed the market BY 39bps as of 1/4/2024. ITB 0.18%  and PAVE 0.18%  outperformed the market by 6.0% and 1.3%, respectively, while IHAK -0.58% , SKYY, ITA -0.19%  trailed.

In January, we have made some adjustments to our recommended individual ETFs. Below are the changes.

• 2 Deletions: SKYY, ITA -0.19%

• 2 Additions: IBLC -4.54% , IBB -0.01%
• 3 Carry-overs: PAVE 0.18% , IHAK -0.58% , ITB 0.18%

Technical Takes from Head of Technical Strategy, Mark Newton.

Global X Infrastructure Development (PAVE 0.18% )
Recent weakness hasn’t served to take away any of the positives of the recent push back to new all-time highs, which happened back in mid-December 2023. Weekly momentum remains positive, and PAVE has still gained more than 4.5% in the last 30-day period. Thus, unless $32.50 is violated, any minor pullback to the $32.50-$33.50 zone should translate into a good risk-reward to buy weakness, in our view. Movement back to $36 initially, then $40 looks likely, and Infrastructure Development remains a bullish sub-sector to overweight following the Industrials sector having pushed to decade highs vs. SPX in 2023.

iShares Cybersecurity & Tech (IHAK -0.58% )
Following an eight-week rally of 25% into mid-December, IHAK has pulled back to help lessen some of its recent overbought state. Technically, IHAK remains in stellar technical shape and a bottoming out and rally back to test all-time highs from November 2021 at $49.09 looks likely in the weeks ahead. Overall, the entire pattern from 2021 represents a giant technical base, making $49 likely a difficult area to immediately surpass. However, weekly momentum remains quite positive and has begun to accelerate in recent weeks, making near-term weakness attractive from a risk/reward perspective. Overall, IHAK looks like a good technical overweight to favor, and gains are likely in the weeks to come.

iShares US Home Construction ETF (ITB 0.18% )
Technically attractive following its push back to new all-time highs in early December 2023. Despite some minor consolidation over the past week, this has been helpful towards alleviating overbought conditions and makes this more appealing to buy dips. Weekly momentum per MACD remains positively sloped and RSI is no longer overbought. A rally back towards $110, then $120 looks likely while strong support lies at 90-93 on any weakness.

iShares Blockchain and Tech ETF (IBLC -4.54% )
Bullish technically following a breakout of a reverse Head and Shoulders pattern back in mid-December which carried IBLC back to new all-time highs. Crypto-related Blockchain and Technology has shown some above-average momentum acceleration in recent weeks, making this sub-group more attractive than the broader market and likely to show above-average relative strength in the weeks ahead. Following a surge up to the mid-$30’s, the recent pullback to $26-$28 constitutes a very attractive technical zone of support, and IBLC is likely to rebound to test and exceed recent highs, en-route to technical targets up near $40.50 which represents a Fibonacci-based alternative extension target. Overall, I view IBLC as quite technically attractive in the mid-$20’s.

iShares Biotechnology ETF (IBB -0.01% )
Biotechnology has begun to show some necessary mean reversion following a difficult 2023 where this sub-industry underperformed sharply, and IBB’s weekly close back up above $127 last month helped to exceed a downtrend from former peaks made in November 2022. It’s thought that Biotech is quite attractive for 2024 as Healthcare begins to make a comeback, and IBB likely should push up to $150 in the months ahead, which represents a 61.8% Fibonacci-based retracement area. While the area near $139 might present temporary resistance following eight straight weeks of gains, IBB’s upshift in price gains have helped momentum to show tremendous strides which aid its intermediate-term attractiveness. Dips into February likely find support near $130, while any weekly close back over $139 should help this advance to $150.

We hope you will find the Sector Allocation Strategy useful in your investment journey. The strategy will be updated on a monthly basis, and we look forward to hearing your thoughts on how we can make it better. If you have any questions about this, or any other aspect of our work, please do not hesitate to e-mail us at inquiry@fsinsight.com.