FSI Sector Allocation - July 2024 Update

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

Market recap

In June, the sector performance of the US stock market mirrored the stock market’s performance year-to-date.

• FANG+ and Technology stocks led the June rally. All 8 components of FANG+ outperformed the S&P 500 in June. NVDA beat the S&P 500 by over 900 bps in June while the lowest performer, NFLX, also beat by 170 bps.
• The S&P 500 rose by 14.5% in the first half of 2024, while FANG+ shockingly outperformed at 17.5%.
• And in the 1H of 2024, only FANG+ and tech ex-FANG outperformed the overall market.
• Many bears believe that the market’s excessive concentration on FANG will eventually lead to market vulnerability.
• However, firstly, the market concentrates on FANG because these businesses represent the directions of most advanced science, technology, and productivity development. They are leaders in their respective industries, not only in the US but globally.
• Moreover, instead of viewing this concentration as a danger, we see it as an opportunity. It shows that the market still has room to rise, especially if other sectors outside FANG+ (and Tech) catch up and the overall market breadth improves.
• Mark mentioned in a recent webinar that the worst-case scenario is if the FANG+ and Tech rally stalls and other sectors cannot fill in promptly. However, Mark also noted that the overall momentum in the Tech sector and FANG+ remains strong. Plus, the overall market is fundamentally sound, especially in terms of earnings. So we are not too worried yet.

Style-wise, not surprisingly, growth led value. This relative strength is more evident in larger stocks where large-cap Growth beat large-cap value by ~770 bps, while mid-cap growth beat mid-cap value by ~340 bps and small-cap growth beat small-cap value by ~170 bps.

Among traditional factors, momentum performed the best – even with the market rising nearly 15%, it still outperformed the market by 19 percentage points, even more than FANG+’s outperformance.

Quality stocks were able to keep the same pace as the overall markets, YTD “slightly” outperforming the market by ~300bps.

For the size perspective, Small caps still trail large caps, especially the mega caps. Small caps’ performance this year has been disappointing to some extent, partly due to the Fed essentially being behind the curve and the unclear path for cutting interest rates.

However, with good inflation data in the recent periods and the start of the global central bank’s cutting cycle, the visibility on future Fed cuts could improve, which could be very beneficial to small caps. Recall last year, when inflation data improved, the Fed turned dovish, and small caps gained more than 25% within two months (Oct 2023 to Dec 2023).

Globally, thanks to technology stocks (especially AI-related stocks), the US stock market has been one of the best-performing major markets.

Overall, we remain constructive on the market. In fact, when the market is strong in the first half of the year, it usually remains strong in the second half.

As shown in the table below, since 1950, there have been 23 years (excluding 2024) where the S&P 500 rose more than 10% in the first half.
• In these 23 years, the median gain in the second half was 9.8% with an 83% win ratio.
• According to historical data, the market is likely to maintain its strength in July. August and September are relatively challenging, then Q4 tends to strengthen again.

Sector ratings

In July, the primary update to our sector rating is Mark upgrading Utilities from UW to Neutral.

For this upgrade, Mark commented:

• The recent strength in Utilities broke through its downtrend relative to the Equal-weighted S&P 500 over the past year and a half.
• However, on an intermediate-term basis, the recent rally did not reverse its broader downtrend relative to the Equal-weighted S&P 500.
• Although Utilities performed as one of the best sectors in the past few months, this outperformance was more due to AI-fueled power demand for data centers rather than traditional defensive trading.
• Therefore, Mark only upgraded Utilities from UW to Neutral.

Below are Mark’s comments on other sectors:

Discretionary

• The short-term rally has been ongoing since mid-May, but overall, it is still in a broader downtrend, so the sector overall still looks quite Neutral.
• The equal-weighted Consumer Cyclical (Discretionary) outperformed the equal-weighted Consumer Defensive (Staples) by over 350 bps in the rolling one-month period, so although currently intermediate-term Neutral rating, Discretionary has been showing some mean reversion-type relative strength, which might last through August.

Industrials

• The minor pullback in the last two months seems to have reached strong support and Industrials looks poised to snap back and outperform into September of this year.

Technology

• Excellent recovery in Technology following its February to April decline has helped to lift this sector’s performance to the best within major S&P sectors on an Equal-weighted basis.
• At 30% of SPX, this sector still looks outstanding following its breakout back to new highs relative to SPX, and pullback to hold support before a sharp rally in May.
• Semiconductor stocks have continued to drive performance and remain technically stronger compared to Software and Tech Hardware.

Communication Services

• Communication Services overall remain neutral. Although there has been some rebound after retesting its 2022 lows, the technical damage suffered this year needs time to recover.
• Communication Services needs to surpass the local high of November 2023 to technically turn bullish. Currently, Communication Services likely rallies into Fall 2024 before stalling out.

Materials

• The recent rally in the dollar made materials one of the worst-performing sectors within the S&P 500.
• However, materials remain attractive technically, especially as the start of US Dollar weakness along with Treasury yields are likely to cause a bounce in commodities and commodity-related stocks in the coming months.
• Breaking the downtrend from 2022 has helped cause a bullish crossover in weekly MACD, and recent weakness should serve as a buying opportunity for a rally back into mid-July.

Energy

• Underperformance is likely in Energy following a sharp bounce in the past week.
• The larger cyclical trend for Energy points lower in the back half of 2024.
• Rallies back above April peaks vs. Equal-weighted S&P 500 are necessary to raise Energy back to an Overweight reading.

Financials

• Financials have improved a bit in the last week but still show negative returns over the last three months.
• The rally in Financials since early 2023 has not yet broken its intermediate-term downtrend line.
• Selectivity is key, but expect Financials likely can rally into late August before a period of weakness ahead of the US Election.

Real Estate

• Recent strength on declining rates helped REITs start to show some relative strength on a short-term basis for the first time in nearly two years.
• The relative bounce to multi-month highs looks to have exceeded a long-term downtrend line from 2022.
• Overall, REITs could be bottoming as long-term interest rates start to retreat.

Consumer Staples

• Consumer Staples remains near multi-year lows vs. SPX. Despite some minor stabilization in the last couple of months, no credible evidence of Staples strengthening has occurred.
• DeMark indicators show that the relative weakness of Equal Weighted Staples against Equal-weighted S&P 500 could reach the level that triggers the monthly TD Combo “13 exhaustion” buy signal by August. At present, it’s clearly premature and additional relative underperformance seems likely.

Health Care

• Healthcare has improved over the last month after four straight months of underperformance.
• Seasonal strength looks likely in July, but thereafter, Healthcare very well might underperform this Fall given the deterioration in its monthly relative chart vs. the Equal-weighted S&P 500.
• Despite stabilization, the larger bounce will need to exceed a lengthy downtrend from 2023 to expect that rallies will prove to be anything more than tactical bounces.
• Overall, Healthcare looks bullish for a bounce, but increasingly is not showing the kind of proper strength necessary to depend on 2H 2024 outperformance.

Tactical ratings
Compared to last month, Broader Technology (Technology + Communication Services) remains the strongest within S&P 500 GICS 1 sectors, while Materials remains the lowest ranking within our tactical momentum matrix.

Defensive sectors are all demoting due to the recent weakness – The ranking of Utilities, Staples, and Healthcare has fallen from #3, #4, #5 to #8, #9, and #10 respectively. Due to this change, we tactically subtract 2% weight from Consumer Staples and Healthcare in July.

Partially thanks to the strong performance from AMZN and TSLA, Consumer Discretionary sees the largest improvement, up from #9 last month to #3 in the most recent update. As a result, we tactically add 2% extra weight to Consumer Discretionary in July.

Energy also sees improvement in momentum, especially due to the rally started in the 2nd half of June. The rankings within the matrix have improved from #10 to #4.

In summary, compared to last month’s allocation, we generally lower the weights for defensive sectors as their short-term momentum deteriorates.

• The weights for Consumer Staples, Healthcare, and Utilities are adjusted lower by -2.1%, -2.3%, -2.1% respectively.
• We added 4.1% and 1.5% weights to Consumer Discretionary and Energy, respectively, because of the improvement of short-term technicals as mentioned above.
• Technology weight is drifted 1.5% higher due to its strong performance recently.
• Weights of Industrials, Communication Services, and Financials are drifted slightly primarily due to their June sector performances.

Compared to the S&P 500 index, we are still more overweight in cyclical sectors (except Basic Materials) while underweight in defensive sectors.

• Our biggest overweights are Technology, Discretionary, and Communication Services, overweighting by 2.8%, 2.1%, and 1.9% respectively.
• Our biggest underweights are Consumer Staples, Basic Materials, and Healthcare, underweighting by -4.2%, -1.8%, -1.5% respectively.
• We are marginally slightly overweight Financials, Industrials, Real Estate, and Energy, but the overweight is less than half a percentage point.
• We recommended a reduced -0.8% weight for Utilities due to its weakness in June. But as you can see in the time series chart, the scale of underweight has been improved compared to last year.

*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 July, we swapped out 4 of the 5 ETF selections from June due to their weak performance.

• Solar stocks have been under pressure in the second half of June. Especially, following the Biden-Trump debate last Thursday, solar stocks see further weakness.
• Similarly for Bitcoin, it has faced a lot of resistance in its attempt to break its prior high in early June. Affected by other headline risks like the Mt. Gox news, Bitcoin was in a downtrend throughout June. Although we remain bullish on Bitcoin in the long term, in ETF recommendations, we decided to recommend other more attractive ETFs.
• Other June ETF choices, COWZ and INFL, failed to keep up with the strong overall market (partially due to their relatively limited exposure to Technology), trailing the S&P 500 by -5.1% and -4.2%, respectively.

In the July recommendations, we still recommend SOXX. As for the above 4 relatively weak ETFs, after discussion with Mark, we decided to replace them with IWF, LCTU, IHAK, and RPG. Therefore, the 5 tactical ETF picks for July are:

iShares Russell 1000 Growth ETF (IWF) <– NEW
Invesco S&P 500 Pure Growth ETF (RPG) <– NEW
BlackRock U.S. Carbon Transition Readiness ETF (LCTU) <– NEW
iShares Cybersecurity & Tech ETF (IHAK) <– NEW
iShares Semiconductor ETF (SOXX) <– carryover