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ETF Current Outlook

ETF Driven Strategy

October Outlook


Tickers in this report: $XLC, $XLF, $XLY, $XLE, $XLK

Well, we are back in the saddle again and looking forward to continuing our journey together.

As a reminder of what the goals are with our sector allocation product.

  • Outpace the S&P500 by actively managing the 11 S&P 500 Sector SPDRs.
  • We are not looking to be super aggressive tactical traders trying to pick every tiny wiggle in relative sector performance.
  • With this being said, we normally have a 6-9 month view, at minimum, try to keep turnover on the lower side, and to beat the S&P 500 by having high Sharpe and Information ratios (i.e., risk adjusted returns).

As we get ready to begin the 3Q21 earnings season, investors seem to be agitating over several issues that are the foundation for a formidable Wall of Worry. With that being said, we are also keeping our eyes on the growing list of potential factors, but importantly our indicator-based investment process remains constructive on the U.S. equity market. Indeed, our research is still pointing to higher highs for the S&P 500.

We certainly acknowledge that the current mix of negatives should not be ignored, and they ultimately may contribute to the end of the current bull market. Clearly, the current backdrop that includes the reawakening of inflation pressures, rising interest rates, energy prices that are moving higher, fears/expectations for tighter monetary policy from the Fed, potential deterioration in corporate operating margins and profit growth, and the lingering impacts from the ongoing COVID cases are suggesting that the path forward for equity investors will be more challenging than the past 18 months.

However, there are still supportive factors that should help buy the equity markets and provide tailwinds for further gains, including the continuation of solid earnings from Corporate America. Based on our work, the fears about the deterioration in margins/profits and negative earnings revisions are overdone. No doubt headline earnings growth for the S&P 500 has been slowing sequentially. This will likely continue into 2022. Yet, this has been our expectation since profits dramatically collapsed during 1H20 as a result of the COVID forced lockdowns. Importantly, the peak and rollover are not likely the end of the current cycle that leads to multiple quarters of outright contraction based on our analysis.

Related to this is the current health of earnings estimate revisions for the overall S&P 500. Our proprietary ASM indicator for the overall index has rolled over, which is not a surprise to us. We had made the case that after the extreme negative reading that occurred during 1H20 that a nearly exact opposite positive reading would be reached. Well, now that the mirror image has been achieved as forecasted, many bearish forecasters are making the argument that the recent rollover is a significant negative for the equity market. We wholeheartedly disagree.

Without going into all the reasons, we will provide what happened following the last earnings revisions collapse, recovery back to extreme positive, and the subsequent rollover that happened during 1Q10, which then trended lower for nearly six years. During this period, the S&P 500 was up nearly 90%. We are not suggesting at this moment that the index is now poised for the same, but simply showing that an overall decline in the ASM line for the broad market is not necessarily a precursor to a bear market.

We at FSI continue to hold the view that active management of portfolios can beat passive strategies over time if one employs a disciplined and data-driven approach to investing. Our research suggests that this is no easy task, but it is clearly obtainable. However, it does take self-discipline and perseverance.

Sector Overview

Although we look at the world from the top down, 90% of our idea generation is derived from a disciplined combination of our proprietary 8-panels and our mix of value-added supplemental tools, which remains the dominant part of our research process and is consistent with FSInsight's data driven approach to research. Granted, we are always aware of the latest macro developments and news stories, but they do not usually have an overly dominant impact on our conclusions like other forecasters. Our quantitatively informed approach helps limit the impact of emotion and bias.

Our new updated sector recommendations are shown below.

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