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Market recap
Happy August! With the dovish FOMC on the last day of July, the S&P 500 finally rallied and turned the month’s performance back to green. The S&P 500 Sectors were generally higher in July except for the broader technology sectors: information technology and communication services.
US Treasuries rallied across all tenors, with the front end shifting downwards more than the far end. Although the Fed did not decide on its first rate cut in the July FOMC as expected, a September rate cut has somehow become the base case, as the market now even starts to price in a ~10% chance for a 50bps cut in the September FOMC.
The DXY dropped by 1.7% from around 106 to about 104. The JPY strengthened to its multi-month high against the USD at the end of July, fueled by the BOJ rate hike. The VIX drifted higher in July, but the absolute level remained below 20.
Moreover, for the stock market, July can be divided into four stages.
- In early July, the market continued its strong momentum from last year, supported by softer-than-expected CPI data and good bank earnings.
- Then the emergence of the Trump trade following the failed assassination led the markets to significant sector rotation.
- As tech earnings season began, increased scrutiny on tech AI spending and headlines on more trade restrictions as part of the ongoing chip crackdown on China accelerated the weakness in the tech sector.
- However, the market’s rebound in the final days of the month reminded us that the Fed remains the single most important factor influencing the market. In the foreseeable future, most market changes will likely still revolve around expectations for the Fed’s upcoming policy path.
In terms of stock market internal dynamics, if there’s one word to describe July, it would be “rotation.” Strong market segments in the first half of 2024, such as big tech, FANG+, large-cap, momentum factor, and growth factors, became weak in July. Previously underperforming sectors like cyclical, small-cap, low-volatility/high-dividend, and value factors performed well in July.
- Sector Performance: while Tech and Communication Services were the only two sectors outperforming the S&P 500 in 1H2024, they both underperformed in July. Real Estate was the only sector down in the first half of 2024 but performed the best in July.
- Style Rotation: Small-cap and value finally outperformed growth. The rotation from large-cap growth to small-cap value in July was evident. The strong momentum factor showed some weakness, while more defensive factors like low volatility and high dividend strengthened.
2Q Earnings so far have been good. Over 60% of the S&P 500 have reported and nearly 80% of the reported S&P 500 companies beat their 2Q earnings estimates with an average surprise of ~4.3%. 2Q EPS has also been revised up by 1% since the end of the calendar quarter.
Sector ratings
Our sector ratings remain consistent with last month:
- Most sector ratings are aligned between Tom and Mark: Industrials, Info Technology, Financials, Real Estate, and Healthcare are overweighted by both, while Communication Services is neutral, and both underweight Staples.
- Energy and Discretionary are overweighted by Tom but neutral-rated by Mark. Basic Materials is neutral by Tom but overweighted by Mark, and Utilities is underweighted by Tom but neutral by Mark.
Tactical ratings
The changes in sector weights in August are mainly due to adjustments in the tactical momentum matrix:
- Financials and Industrials, boosted by the Trump trade and the expected start of the Fed easing cycle, advanced higher in the rankings.
- Communication Services remains second in the rankings, primarily due to its high rank in DQM and RSI.
- Commodity sectors, Basic Materials and Energy, along with Consumer Discretionary, are ranked at the bottom of the metrics.
- Technology fell from the top three, showing weakness in momentum and price trends but remained out of the bottom three due to high ranks in all three models (DQM, IBD EPS, IBD RSI).
- Healthcare and Consumer Staples showed relative improvement in momentum, advancing from the bottom three to the middle “tactical neutral” zone.
Combining sector ratings with tactical momentum adjustments, compared to last month:
- We reduced the allocation to Discretionary by 4% due to its drop in momentum ranking.
- We increased the weights in Industrials and Financials by 2.3% and 2.8%, respectively, due to relative price gains and improved momentum.
- We reduced the recommended weight for Technology by 3.4%, 2% due to deteriorated momentum, and 1.4% due to weak performance in July.
- The weight in Energy was reduced by 1.9% due to deteriorated momentum.
- Recommended weights for Healthcare and Staples were increased by 2.3% and 2.1%, respectively, as they advanced from the bottom three in the momentum matrix.
Compared to the overall S&P 500 index, based on the final weight results, we are now overweight:
- Financials +2.5%
- Industrials +2.4%
- Communication Services +2.0%
- Technology +0.9%
- Healthcare +0.5%
- Real Estate +0.3%
We are underweighting:
- Utilities -0.8%
- Discretionary -1.8%
- Materials -1.9%
- Energy -1.9%
- Staples -2.3%
*The above weights are based on an 85% Sector ETF + 15% Tactical ETF allocation. For a 100% Sector ETF allocation, refer to slide 43 in the attached deck.
Special Note on Sector ETFs
Historically, SPDR Sector ETFs have been good investment vehicles for replicating S&P 500 sector performances. However, due to the increasing concentration of large-cap tech over the past few years, the ETF’s weight cap restrictions now cause some SPDR ETFs to not track sector performance precisely.
For example, due to the weight cap, NVDA was materially underweight within the XLK ETF earlier this year. As a result, XLK YTD has trailed the technology sector index by more than 1000bps.
This weight cap in the most recent rebalance also caused the XLK ETF to be materially underweight AAPL. As shown in the chart below, AAPL’s weight within the S&P 500 Information Technology sector is around 22.7% as of July 31. However, according to XLK’s holdings, due to the weight cap, AAPL’s weight is only 4.9%. Simple math implies that to bring AAPL’s weight closer to the sector weight, one needs to buy an additional $18-$23 in AAPL separately for every $100 investment in XLK.
ETF Picks
As the rotation out of growth continues, three of the five individual ETF picks underperformed the S&P 500 in July, with SOXX down the most, trailing the S&P 500 by 5.7%.
In the August recommendations, our focus is on the sector rotation and cyclical trade. Therefore, we have removed four ETFs from the recommendation list, except for IHAK. The new five ETF recommendations are:
- SPDR S&P Regional Banking ETF (KRE -1.81% ) <– NEW
- iShares Biotechnology ETF (IBB -0.06% ) <– NEW
- iShares Core U.S. REIT ETF (USRT -0.90% ) <– NEW
- Global X U.S. Infrastructure Development ETF (PAVE -0.58% ) <– NEW
- iShares Cybersecurity & Tech ETF (IHAK 0.54% ) <– carryover
Please don’t forget to tune in to Mark’s live technical analysis today at 2pm. You can watch it directly from the event page by clicking this LINK.
