Please CLICK HERE to download the May sector allocation report in PDF format.
Market recap
Happy May FS Insight Family!
After a strong start in Q1, the stock market experienced some volatility throughout April. Influenced by tax selling, hotter-than-expected CPI, hawkish Fedspeaks, and disappointing earnings from some high-profile companies (notably from META), we observed significant deleveraging, for example hedge funds’ short interest surged to 2022 levels, the VIX futures term structure inverted, and market indicators such as the percentage of members below their 20-day average dropped to 8%, an extremely oversold reading. At the worst, the S&P 500 dropped nearly 5.5% from its high at the end of March. However, thanks to GOOGL, MSFT, and even TSLA, the stock market once again showed resilience. And despite the influence of weaker-than-expected GDP numbers, hotter-than-expected GDP price index, PCE, and ECI in the last few trading sessions, the stock market managed to recover a bit and finished April down 4.2%.
The sector performance in April also reflected the deleveraging we experienced. All sectors were lower on an absolute basis. Relatively speaking, defensive sectors such as Consumer Staples and Utilities led in April. Additionally, due to the intensification of geopolitical conflict in the Middle East, the Energy sector also performed well, outperforming the S&P 500 by a notable margin. Despite the disappointing guidance from META during its earnings release, overall, the FANG+ stocks actually outperformed the market by 1.3%. Communication Services excluding FANG+, Real Estate, and Discretionary excluding FANG+ lagged the most. Particularly, Real Estate and Discretionary excluding FANG+ have been underperforming the market each month in 2024.
From a style perspective, the size factor appeared to show the most significant characteristics in April. Larger cap stocks, relatively speaking, did a better job than smaller cap stocks. The performance hierarchy was Mega cap > S&P 500 > Russell Mid Cap > Russell 2000, with smaller caps being hit the hardest during this deleveraging process.
Regarding growth versus value, large cap Core stocks (those that are included in both growth and value indices) performed the best, as both growth and value outperformed their corresponding pure growth and pure value indices. The same situation applied to Midcap growth versus value. Across the entire SMID growth versus value segment, although they all underperformed the S&P 500, generally speaking, SMID value performed slightly better than SMID growth.
As for other factors, April marked the first time in 2024 that the momentum factor has not been working. Despite this, momentum remains the best performing factor/style year-to-date, outperforming the S&P 500 index by more than 1000 basis points. On the other hand, given the deleveraging in April, it is not surprising that the high Dividend/low volatility styles were the best performers.
Sector Ratings
Regarding sector ratings, the ratings from our Head of Research, Thomas Lee, remain unchanged. Mark Newton, our Head of Technical Strategies, made two adjustments to his sector ratings:
- Basic Materials: upgraded from Neutral to Overweight (OW).
- Health Care: upgraded from Neutral to Overweight (OW).
Basic Materials: Mark had upgraded Basic Materials from Neutral to OW earlier in April. From his perspective, the equal-weighted Material ETF is a better gauge of the sector’s strength due to the concentration of market cap in a few large stocks, such as LIN, FCX, and SHW. From a relative standpoint, equal-weight Materials has reversed its recent downtrend versus the Equal Weight S&P 500 in mid-March. Despite the recent volatility caused by rising interest rates and falling commodity prices, Mark anticipates the Materials sector to strengthen into the summer.
Health Care: The Healthcare sector was temporarily downgraded by Mark in late March due to its relative strength versus the S&P 500 on an equally weighted basis. As the relative performance reached former lows and gradually stabilized, Mark predicts Health Care will start to turn higher. Many technical indicators, such as the DeMark TD Buy Setup, along with historical seasonality, are supportive and make Healthcare timely. Therefore, Mark upgraded Healthcare back to OW on April 23, anticipating some sharp outperformance likely to occur between now and July.
Tactical Sector Momentum
In addition to adjustments in sector ratings, our tactical sector momentum matrix has also seen some small changes:
- Overall, due to the good performance of defensive sectors, their ratings in the tactical metrics have improved. Consumer Staples improved from the bottom 3 to 5th place. As a result, the previous weight decrease caused by the low ranking has been added back. Healthcare and Utilities moved up from 5th and 6th to 3rd and 4th, respectively. Consequently, Healthcare’s weight was increased by 2% in the May rebalance.
- Communication Services and Financials, due to poor performance in April, fell from the top 2 to 6th and 8th places, respectively.
- Technology and Materials remain in the bottom 3 positions, and due to the weakness of Real Estate in April, its ranking also fell to the very bottom.
- The top 3 sectors with the best short-term trend are Industrials, Consumer Discretionary, and Healthcare. Their high rankings in tactical momentum led to an increase in their weights by +2%.
- The bottom 3 sectors with the worst short-term trend are Technology, Materials, and Real Estate. This month, we will temporarily reduce their weights by -2%.
In summary, compared to last month’s allocations:
- Due to adjustments in tactical momentum, we have reduced the weights of Communication Services, Financials, and Real Estate, while increased the weights of Discretionary, Healthcare, and Consumer Staples.
- The minor changes on weights for Industrials, Technology, Energy, and Utilities were primarily due to their sector performance relative to the S&P 500 in April.
Compared to the overall S&P 500 index:
- Our largest Overweight (OW) positions are in Healthcare, Industrials, and Discretionary. We recommend an additional weight of +2.5%, +2.4%, and +2.2%, respectively.
- For Energy and Financials, we recommend marginally additional weights of +0.4% and +0.6%, respectively.
- For Technology, as mentioned earlier, due to its weak ranking in the tactical momentum matrix, we recommend a reduced weight of -1.1% relative to the S&P 500. If the momentum for Technology improves later, we will reconsider and potentially recommend additional weight for this sector.
- Due to Underweight (UW) sector ratings from Tom, we recommended a reduced weight of Utilities and Consumer Staples by -0.8% and -2.3%, respectively.
- Based on our systematic approach for this sector allocation, we currently recommend zero weight for Materials and Real Estate. However, as mentioned earlier, our Head of Technical Strategy, Mark Newton, does favor Basic Materials and sees this sector as constructive going into the summer.
* The above-mentioned weights are based on an 85% Sector ETF + 15% Tactical ETF allocation. If you are 100% allocated to Sector ETFs, you can refer to slide 43 in the attached Deck.
Tactical ETF Picks
In April, influenced by a broader risk-off environment and deleveraging, our tactical ETF picks underperformed the stock market, trailing by an average of 5.7%.
- Among these, the biggest laggard was BITB, which, affected by the decline in Bitcoin, was down 16.8% in April and trailed the market by 12.7%. Despite this, we maintain a constructive stance on Bitcoin from both a fundamental and technical perspective. Therefore, in our May tactical ETF picks, we continue to recommend holding BITB.
- Additionally, PAVE and SOXX are still favored by our head of technical strategy, Mark Newton. ARKW and ITB have been replaced by PHO and ITA from relative strength perspective.
- The 5 tactical ETF picks for May are PHO 0.19% , BITB 1.23% , ITA -0.08% , PAVE -0.34% , and SOXX 0.54%
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.
