FSI Sector Allocation - February 2024 Update

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

Happy February to the FS Insight family!

In the past January, the market zigzagged higher. Most notably, after experiencing declines of up to 25%, the market finally reached a new high at the close on January 19th.

Looking at sector performance, the overall leadership pattern was quite clear. In the first 3 trading days of January, the cyclical sector was under significant pressure, while the broadly defensive sectors performed relatively well.

However, starting from the fourth trading day, the cyclical sectors, or more specifically, technology, made a strong comeback. The technology sector outperformed the overall market for 12 consecutive trading days, pushing the market to new highs. Although technology’s momentum slightly waned in the final sessions, with broadly defensive sectors making a comeback, technology remained the top performer of the month, outpacing the overall index by 2.3%.

Financials and healthcare also performed well, each surpassing the overall index by 1.3%. Consumer Discretionary, Basic Materials, Real Estate, and Utilities were mainly lagging, down by more than 3%.

Sector Ratings
Compared to last month’s outlook, the biggest change this month comes from Mark’s overweight of Financials and Healthcare.

• Financials – As Mark noted in his note on January 24th, the downtrend that has been in place since the beginning of 2022 has been exceeded, which should drive near-term performance into the summer. Therefore, Mark tactically raised the rating of financials from Neutral to Overweight. Regarding Financial stocks, Mark believes it’s best to stick with those within striking distance of their 52-week high, for more details see Mark’s note on January 24th.

• Healthcare – The momentum in Healthcare has been gradually strengthening. Especially after the close on Thursday, it broke through the recent highs, and just a step away from the all-time high in April 2022. Mark noted on Wednesday that Healthcare has officially broken a one-year downtrend relative to the S&P 500 and is likely to outperform the S&P 500 in the first half of 2024. Hence, Mark upgraded healthcare to Overweight in February and expects this outperformance could last 5-7 months.

• Financials and healthcare, besides technology, are the only other two sectors that outperformed the overall market in January. Hence, the upgrade of financials and healthcare is timely. Additionally, as the second and third largest sectors behind technology, the outperformance of financials and healthcare also reflects an overall improvement in market breadth. Recall, in our 2024 outlook, one of the main consensus points shared by Fundstrat research heads was that we believe the main driving force for the stock market rally in 2024 would come from various sectors, ala improving market breadth. Thus, the outperformance of Financials and Healthcare is welcomed.

• After Mark’s upgrade of Financials and Healthcare, now Tom’s and Mark’s sector ratings are largely aligned. The only two sectors that are not aligned are Consumer Discretionary, which Tom is overweight while Mark is neutral, and Real Estate, which Tom is overweight while Mark is underweight.

Tactical Adjustment
Aside from the slight adjustments in sector ratings, our tactical sector momentum matrix also has some minor changes.

• The Top 3 with the best short-term trend remain Communication Services, Financials, Healthcare, although the order has changed.
• Last month’s 3 tactical underweight sectors, Materials, Consumer Staples, Consumer Discretionary, have all seen an improvement in momentum. In this month’s update, Energy, Utilities, and Real Estate have fallen to the bottom three. Therefore, we also tactically lowered the weighting of these three sectors.

Overall Results
Overall, compared to the benchmark S&P 500 index, our model suggests:

• Allocating more weight in Healthcare, Financials, Communication Services, and Technology.
• Overweighting Industrials and Discretionary slightly.
• Underweighting Energy and Real Estate primarily for tactical reasons and underweighting Consumer Staples and Utilities.

Tactical ETF Picks
Since the January sector allocation was published, our January tactical ETF picks on average trailed the S&P 500 by 3.8%.

• The primary underperformance came from IBLC -4.54% . Partially due to the “sell the news” as well as possibly GBTC redemption, crypto and crypto equity faced selling pressure after the approval of the Bitcoin spot ETFs. Although the price of IBLC -4.54%  recovered towards the end of the month and we remain constructive on crypto and crypto equity over the long term, we decided to swap out IBLC and substitute it with more timely ideas in this February update.
• Another deletion is IBB. As mentioned above, the Healthcare sector as a whole is doing well, but if we look at the internal dynamics of the sector, Medical Devices seem like a better area to own compared to Biotech even though both Medical Devices and Biotech are likely to work in the next few months.

We still favor PAVE 0.18% , IHAK -0.58% , and ITB 0.18% . The updated 5 tactical ETF picks are PAVE 0.18% , IHAK -0.58% , ITB 0.18% , SOXX, and IHI -0.04% .

Below are Mark’s commentary on the latest 5 tactical ETF Picks.

Global X U.S. Infrastructure Development ETF (PAVE 0.18% )
PAVE is quite attractive as the Global X Infrastructure Development ETF has just pushed back to new all-time highs this week with its close back above $34.93.

Technically, this is quite constructive and should allow for a coming rise to $37.10, and then a possible rally to $39.65 before this begins to stall out.

Despite the lengthy consolidation in PAVE between July and October of last year, Infrastructure stocks started to gain ground when PAVE closed back above August 2023 highs in mid-December 2023.

Momentum has not been too overbought given the consolidation from December and makes this a timely candidate technically speaking given this week’s breakout.

Overall, I expect PAVE’s relative performance to strengthen in the weeks ahead based on this week’s breakout and higher prices look likely.

iShares Cybersecurity & Tech (IHAK -0.58% )
IHAK’s rise to within striking distance of former all-time highs does not suggest an imminent slowdown, and no real resistance lies between current levels and late 2021 peaks near $49.09.

Weekly momentum has begun to show some negative divergence, but 4-5% gains are likely initially to test the old November 2021 peak sometime this February.

Despite this being a temporary area of possible resistance, the act of climbing over $49.09 would allow for a push up to the low $50’s.

Overall, this ETF remains one to hold despite some churning in recent weeks as IHAK has risen for the last 11 of 13 months, and a coming test of all-time highs looks likely in the near future.

Near-term support to buy weakness lies near $45 with strong support found at $43.25.

iShares U.S. Home Construction ETF (ITB 0.18% )
US Home Construction stocks rapid gains from late 2023 occurred as Treasury yields were pulling back sharply and this looks to have begun again in the last week with TNX pullback to 3.88%.

This latest week of Treasury gains (Yields pulling back) has directly coincided with ITB lifting back to within striking distance of new all-time weekly highs on a closing basis, and I expect ITB should break out in the days to come, with targets near $111.25, and a probable maximum move in the month of February up to $126 before consolidation gets underway.

ITB’s gains of 35% in the last three months don’t look sustainable in the long run. However, rates likely have a lower trajectory in 2024 and this should keep prices pushing higher.

Strong support lies near $90 and this is likely to provide a cushion on any initial Spring decline.

At present, another 7-10% gains look possible, and it’s right to continue to favor Builders/Home Construction stocks as yields pull back.

iShares Semiconductor ETF (SOXX)
December’s rally back to new all-time highs solidified Semiconductors as one of the top sub-groups to favor for possible outperformance. In recent weeks, this has shown some mild consolidation following three straight months higher.

However, it remains difficult to consider fading a move back to new all-time highs despite being near-term overbought.

Monthly momentum indicators like RSI have begun to show negative divergence after this peaked back in 2021 and has not recouped this high despite the recent price spike back to new all-time highs.

However, with stocks like ASML, NVDA, AMD, and AVGO having all risen more than 25% in the last six months, it will be necessary to show at least some evidence of near-term momentum slowing further before expecting that price might be peaking out.

The act of rising back to new all-time highs in the last few weeks often presents the opposite conclusion, and supports the idea of additional gains, as technical structure has improved, not deteriorated.

Upside targets for SOXX lie near $680 and should involve further strength into mid-February by the former outperformers like NVDA, AMD and others.

iShares U.S. Medical Devices ETF (IHI -0.04% )
IHI has proven to be even stronger within Healthcare than Biotech lately, so it makes sense to favor this sub-sector within Healthcare for additional absolute and relative outperformance.

As demonstrated in the report on Wed, its ratio chart vs. IBB just broke out to the highest level in weeks, which bodes well for better relative performance out of IHI than IBB. However, potentially more evident, but no less bullish is the absolute breakout which is happening this week, as IHI has exceeded the entire downtrend from 2021.

Overall, given Healthcare’s reemergence lately with XLV nearly having made new all-time high monthly close for January, Healthcare should be favored for outperformance in the months ahead.

Medical Devices has started to show a bit more strength as interest rates have trended lower, and the last couple weeks of pullbacks in rates have directly coincided with above-average strength.

The act of being over $55.40 represents an IHI -0.04%  breakout of a downtrend that has been ongoing since late 2021 and makes this appealing for additional short-term gains.

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.