Please CLICK HERE to download the sector allocation report in PDF format.
Market Recap
Monday marked the final trading day of both September and the third quarter. Yesterday’s market action was like a microcosm of the entire month.
- The market interpreted Powell’s speech at the NABE as hawkish, as he emphasized there was no urgency to cut rates quickly. However, the market soon recovered and hit new highs again. Earlier in September, we experienced an intensified selloff.
- Similarly for September, when the market drops significantly in the first week of September, historically it’s hard for the market to recover quickly in the remainder of the month.
- However, 2024 has proven to be an extraordinary year, highlighting the market’s resilience. Boosted by the beginning of a major rate-cutting cycle, the market ended the month positively and pushed the YTD gain to 20.8%.
In fact, historically speaking, the first 3Q performance of stock market this year has been phenomenal—since 1950, this year’s 20.8% return through Q3 ranks ninth – It reminds us just how strong the markets have been (up 8 of the last 9 months).
The GICS 1 sectors were generally higher, except for Financials, Healthcare, and Energy. Utilities led the market, up 6.4% in September. Traditionally, Utilities are seen as a more defensive sector, but with the tailwinds of AI, Utilities have essentially become an AI play. In fact, YTD Utilities’ performance is second only to FANG+, making it the second-best-performing sector.
Following Utilities, all cyclical sectors rose in September, with Comm Services ex-FANG+ and Discretionary ex-FANG+ up 4.8% and 4.7%, respectively. The performance of FANG+ itself has not been bad either. Especially the laggard within FANG+, TSLA 3.28% , saw a big rebound, up 22.2% in September. October will be important for TSLA, not only due to its quarterly delivery stats coming out tomorrow + its earnings release later, but also for the highly anticipated robotaxi unveiling.
Real Estate also performed well in September. This often-overlooked sector has been on an upward trend for the past five months. Real Estate especially benefits from Fed rate cuts—not only do lower rates help property valuations and reduce financing costs, but REITs’ high dividends also become more attractive.
Looking toward the year-end, we remain constructive on the stock market.
Firstly, from a seasonality perspective, the fourth quarter of the year tends to be strong. As shown in the chart below, we calculated the 4Q median return under different Q1-Q3 market performances.
– The strength of Q4 seems unrelated to how the market performed in Q1-Q3, as Q4 tends to be positive regardless.
– Of course, the performance within 4Q can vary depending on the performance of the first three quarters.
– Historically, when Q1-Q3 has been strong (up >10%), October tends to be weak, while November and December see rallies.
– This may coincide with mutual fund tax selling or October rebalancing, but overall, the 4Q average return doesn’t differ much.
On the macro front, Fed easing, China stimulus, and post-election dynamics will continue to catalyze the stock market (as we noted in recent macro notes). Thus, stay on target!
Sector Ratings
The only change in this month’s sector ratings is Mark’s downgrade of healthcare from Overweight (OW) to Neutral (N):
- Following the Fed’s recent 50-basis-point rate cut, the sector began to decline sharply.
- As mentioned earlier, Healthcare is one of three sectors that posted negative returns over the past month (the other two being Consumer Staples and Energy).
- Healthcare’s summer rebound didn’t last long enough to reverse the relative downtrend (RSPH/RSP) since last summer, and the sector declined sharply in recent weeks.
- Overall, Mark believes that additional relative weakness might be likely in the next few months. For now, he is only downgrading the technical rating to neutral in case defensive positioning reemerges in the months ahead.
Here are Mark’s comments on other sectors:
Consumer Discretionary:
- The relative strength of the Consumer Discretionary sector has significantly increased in recent months and may perform well from mid-to-late October. YTD, it has outperformed Consumer Staples, and the ratio to Consumer Staples is at its highest level since late 2021, signaling a rise in risk appetite.
- Despite a continued downtrend relative to the S&P 500, a near-term outperformance is possible before this sector slows.
Industrials:
- The equal-weight Industrials sector hit a record high this week, signaling bullish momentum, as the minor pullbacks of the past two months have ended with clear upward movement.
- Transportation stocks could begin to outperform given DJ Transportation Average being on the verge of a technical breakout.
Technology:
- Following consolidation, we have seen an excellent comeback in Technology sector. Semiconductors rebounded after a period of underperformance, and both software and hardware stocks show evidence of breaking out.
- Despite recent weakness, as a 30% component of the S&P 500, its outlook remains favorable, with key stocks like Apple performing strongly.
Communication Services:
- Despite recent bounces, the sector remains neutral due to its choppy, sideways trend relative to the S&P 500 since the beginning of the year.
- A breakout above November 2023 highs is needed to turn this sector bullish. Currently, Communication Services may rally into Fall 2024 before stalling.
Materials:
- The Materials sector performed strongly recently, driven by positive factors such as China’s stimulus. In the past week, equal-weight returns were +3.82%, making it the best-performing sector.
- The relative trend vs. the S&P 500 held its 2024 lows and hit multi-week highs last week. Paper stocks, metals, and mining have become more attractive.
Energy:
- The Energy sector fell to its lowest level relative to the S&P 500 on an equal-weighted basis in two years and is expected to remain weak.
- The broader cyclical trend for Crude Oil points lower for the second half of 2024 into 2025. Alternative energy such as solar looks to be one of the better areas within Energy.
Financials:
- The Financial sector broke its downtrend from early 2022, which has helped to improve its attractiveness in recent weeks.
- Insurance, exchanges, and large-cap bank stocks have performed better than small-caps lately, and the rally is expected to continue into next spring.
Real Estate:
- Supported by falling rates, REITs broke out of their 2022 downtrend but remain in an intermediate-term downtrend.
- Falling long-term rates may form a tactical low for REITs. Rally in this group looks likely into next Spring as the Treasury rally continues.
Consumer Staples:
- Consumer Staples continue to trade at decade+ lows relative to the S&P 500. YTD, they’ve only outperformed the Energy sector.
- DeMark counts on weekly relative charts of RSPS to RSP +0.01% indicate downside exhaustion by mid-October. A monthly TD Combo “13 Exhaustion” signal (Buy) is present but unconfirmed for the first time since October 2021. Further relative weakness seems likely from this sector.
Utilities:
- On an equal-weight basis, near-term outperformance is likely for Utilities over the next few months, as part of intermediate-term downtrends. DeMark counts on monthly charts suggest possibly 2-3 more months of relative outperformance.
- The technical rating was raised to neutral a few months ago due to recent outperformance, but most of the strength came from Power Generation stocks, and Utilities outperforming as Treasury yields began to retreat.
- On an intermediate-term basis, the minor rally has not changed the larger downtrend in Utilities.
Tactical Rankings
Given that the stock market continues to follow its prior trends, there were minimal changes to the tactical rankings.
- The top 3 remain Technology, Communication Services, and Financials, with minor position shifts.
- Real Estate and Basic Materials benefited from their recent strong performances and escaped the bottom 3.
- Consumer Staples and Healthcare, due to recent technical deterioration, have now fallen into the bottom 3.
- Energy remains the lowest-ranked sector. However, it’s worth watching if China’s stimulus will translate into real economic growth, boosting oil demand. The potential expansion of the Middle East conflict also bears watching, though it has yet to significantly impact oil supply or prices.
Overall, compared to last month’s sector allocation, we’ve increased our weighting toward cyclical sectors (partially benefiting from their relative outperformance in September as well).
Energy and Financials weightings were reduced slightly due to their underperformance in September, while Real Estate saw a 2.1% increase, as it escaped the bottom 3tactical rankings.
The biggest decrease in weight came from Consumer Staples and Healthcare, both of which slid into the bottom 3 in the tactical rankings. Mark’s downgrade of Healthcare to Neutral further contributed to its decreased weighting.
The Utilities weighting remains unchanged.
Compared to the overall index (*), Technology, Financials, and Communication Services are still our most overweight sectors, with additional weights of 3.0%, 2.6%, and 2.0%, respectively.
We also assigned an additional 0.2-0.6% to other non-defensive sectors like Consumer Discretionary, Industrials, and Real Estate.
On the other hand, our largest underweight is in Consumer Staples—down 4.3% versus the index, while Energy and Healthcare are underweighted by 1.9% and 1.8%, respectively.
Utilities are still underweighted by 0.9% compared to the index, but the underweight has decreased from before.
*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.
About the SPDR Tech Sector ETF (XLK 0.50% )
In previous sector allocation reports, we mentioned the tracking error between XLK 0.50% (Technology Select Sector SPDR ETF) and the S&P 500 Technology sector. This issue should significantly improve following the latest SPDR ETF rebalance (link).
In the most recent rebalance, the index team made adjustment on the rule of limitations on the weight cap of certain components. As shown in the chart below, based on prior index rule, one of the big three tech stocks (AAPL 0.36% , MSFT 0.80% , NVDA 0.70% ) would always have its weight drastically restricted (at the beginning of the year, it was NVDA 0.70% ; recently, it was AAPL 0.36% ). After this adjustment, this weight cap should be largely removed, and the previous tracking error should improve. We will continue to monitor this change and its effects.
ETF Picks
In September, our five ETF picks rose by an average of 0.5%, but underperformed the S&P 500 by 1.5%.
- Regional banks (KRE -1.81% ) and Biotech (IBB -0.06% ) were the laggards, down -2.1% and -1.7%, respectively.
- The infrastructure ETF (PAVE -0.58% ) was the best performer among the five, up 4.4% in September.
For October, we decided to replace KRE -1.81% , IBB -0.06% , and PAVE -0.58% with FINX -1.16% , ITB -1.50% , and ARKQ 0.87% .
- FINX -1.16% and ARKQ 0.87% both show signs of a breakout, coupled with strong momentum.
- ITB -1.50% also shows a strong uptrend, and more importantly, the launch of the Fed easing cycle could benefit homebuilders fundamentally.
- By the way, October is also the start of the “Golden Six Months” for homebuilders. For those who recently joined us, Tom and the team have written the interesting seasonality of homebuilders years ago, showing that these stocks tend to rise from October to April (next year). The underlying reason may be related to the seasonality of the housing market itself. Of course, past performance does not guarantee it will definitely repeat in the future, but this is worth watching over the next six months.
