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Market recap
As one of the oldest Wall Street adages says, “sell in May and go away.” Historically, May often marks the beginning of a seasonal downturn in stocks. However, this past May defied that trend as the S&P 500 finished the month by up 5.8%. This continues the strong performance since last October and, more broadly, since the bottom in 2022. This strength is not surprising, as we have previously noted that if the market rises in the first 3 months of the year and falls in April, there is a 73% probability that May will still see gains. If this trend continues to play out, June might perform even better historically, with markets up 11 out of 11 ex-bear instances, with a median gain of 3.9%.
Aside from the historical studies, the fundamentals of stocks are also strong. In the past 1Q earnings season, 82% of stocks beat estimates. The 7.4% weighted average surprise factor is the highest in recent years. Since the earnings season started, the estimated FY2024 EPS growth estimates have been up from 9.9% to 10.7% and almost all sectors see a greater eps growth in 2024 except Healthcare and Industrials.
Particularly in AI, NVDA once again crushed expectations, propelling AI-related stocks to push the Nasdaq to new highs. Additionally, it’s encouraging to see more companies genuinely getting involved in the AI wave, not just in stock prices but also in AI spending and transformation. Based on the data compiled by FactSet, the number of companies citing “AI” on earnings calls reached a new high during 1Q2024, with a broadening of companies from all 11 sectors now citing AI.
In terms of sector performance, except Energy, all sectors were higher on an absolute basis. Relative performance also showed the trend of AI wave – benefiting from AI, FANG+, and Utilities were two of the three sectors outperforming the S&P 500. The other one, Real Estate, notably outperformed the S&P 500 for the first time after trailing for four consecutive months, albeit marginally.
On the laggard side, aside from Energy, Discretionary ex-FANG also trailed the S&P 500 significantly. This wasn’t just because Amazon and TSLA were excluded. In fact, AMZN and TSLA fell by 4.0% and 7.6% respectively compared to the S&P 500.
Sector Ratings
For June, we remain constructive on the market, from many aspects such as seasonality, inflation/macro trend, and sentiment, etc (see Tom’s note on June 3 and Mark’s note on May 31). In terms of sector ratings, most remained unchanged, with the only change being Mark upgrading Real Estate directly from Underweight (UW) to Overweight (OW), and downgrading Energy from OW to Neutral:
Real Estate
Real Estate has been the biggest point of disagreement between Tom and Mark in their sector ratings this year. Tom upgraded Real Estate to OW last December in his 2024 Outlook based on easing financial conditions and a recovery in the overall CRE segment. Mark, based on technical considerations, felt Real Estate was not yet timely.
However, recently, with Real Estate strengthening relatively (boosted by the falling interest rates), Mark decided to upgrade Real Estate to OW. The recent BofA fund manager survey also shows the allocation to Real Estate decreased by 13% over the past month to a net 28% underweight. This is the largest underweight since June 2009 for global portfolio managers. So, literally, the current underweight level of Real Estate is at the level seen post-housing bubble burst.
Interestingly, Tom recently commented Real Estate in one of the FSI webinars, and compared it to the Energy sector in 2020. Recall that the economic demand slump due to COVID-19 even caused crude oil prices to drop into negative territory. The Energy sector’s weight in the S&P 500, which was over 15% at its peak (pre-GFC), fell to below 2% at its lowest during COVID.
Today’s Real Estate sector is similar to the Energy sector back then, somehow “abandoned” by investors as evidenced by the BofA survey mentioned above, and now comprising just over 2% of the S&P 500 weight. If the story of Energy four years ago repeats in Real Estate, the FOMO could create a sizable upside for Real Estate. Fundamentally, we believe this could play out as our base case remains that inflation will fall faster than the consensus, and the internal dynamics of inflation are not as hot as the reported numbers suggest. Therefore, the Fed could remain dovish and facilitate easing financial conditions.
In summary, the alignment of Tom’s fundamental view and Mark’s technical view on Real Estate is a good sign.
Energy
Mark downgraded Energy from OW to Neutral primarily due to the technical deterioration in both the sector’s price performance and crude oil prices.
Following the OPEC+ agreement over the weekend on extending voluntary and group-wide production cuts into 2025, both XLE and OIH broke support on Monday. The violation of May lows suggests WTI Crude oil could revisit the lows seen last December in the high $60s.
Therefore, Mark expects the Energy sector to underperform further into late July and remains Neutral until the price stabilizes and technical trends strengthen.
Tactical Rating
Compared to the past few months, this month’s tactical rating changes are relatively significant.
- The broader technology sectors (Tech and Comm Services) rose to 1st and 2nd, with Utilities (now sort of tech thanks to AI) rising to 3rd.
- Commodity sectors remain very weak, with Energy falling from 7th to 10th, and Materials falling from 10th to last, 11th.
- Industrials and Discretionary, which were the highest-ranked last month, also saw deterioration, falling from 1st and 2nd to 8th and 9th, respectively.
- Healthcare’s relative short-term strength slightly weakened, falling from the top 3 last month to 5th.
- Real Estate, which was at the bottom last month, saw the largest improvement, rising to 6th.
Based on these short-term momentum ratings, we tactically allocate an additional 2% weight to Communication Services, Information Technology, and Utilities, and tactically reduce 2% weight from Consumer Discretionary, Energy, and Materials.
In summary, compared to last month’s allocation:
- We have lowered the weights of Consumer Discretionary, Industrials, Energy, and Healthcare. The largest adjustment was in Consumer Discretionary due to its short-term momentum falling from one of the top 3 sectors last month to one of the bottom 3 sectors this month.
- Real Estate saw weight adjustments higher due to both strategic rating upgrades and tactical rating advances.
- Financials and Consumer Staples weights changed slightly, mainly due to their sector performance relative to the S&P 500 in May.
- Currently, our model still suggests assigning 0 weights to the Basic Materials sector.
Compared to the overall S&P 500 index:
- Our largest OW is in Technology, Communication Services, and Utilities. We recommend additional weights of +2.8%, +2.0%, and 1.1%, respectively.
- For Healthcare, Financials, Industrials, and Real Estate, we recommend marginally additional weights from +0.3% to +0.5%, respectively.
- Due to Mark’s downgrade of Energy along with its recent weakness, we currently recommend a reduced 1.7% weight for Energy compared to the benchmark index.
- We currently recommend reduced weights for both consumer sectors, while Materials, as mentioned above, remains at 0 weight compared to the benchmark index.
*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 May, with the market rebound, our five tactical ETFs averaged up by 7.2% since the last report, beating the S&P 500 by 220 bps. Among them, BITB was up the most, rebounding strongly after Bitcoin’s April decline. BITB was up by 17.3% since April 30th, beating the S&P 500 by 1240 bps, recovering its April underperformance. SOXX, helped by NVDA (and other semiconductor names), was up 9.5% in the same period, beating the S&P 500 by 460 bps.
For June, we still recommend keeping BITB and SOXX. After consulting with Mark, we decided to replace the other 3 weaker ETFs with TAN -1.33% , COWZ -0.81% , and INFL 0.34% . Therefore, our five tactical ETF picks for June are:
- Bitwise Bitcoin ETF (BITB 1.23% ) <– carryover
- iShares Semiconductor ETF (SOXX 0.54% ) <– carryover
- Invesco Solar ETF (TAN -1.33% ) <– NEW
- Pacer US Cash Cows 100 ETF (COWZ -0.81% ) <– NEW
- Horizon Kinetics Inflation Beneficiaries ETF (INFL 0.34% ) <– NEW
By the way, the selection of INFL is purely based on a technical perspective. It doesn’t alter our fundamental view on potential inflation trends.
