FSI Sector Allocation - January 2025 Update Array ( [cookie] => 6889a5-5f4bfe-656a3e-8224e0-9e6ae9 [current_usage] => 2 [max_usage] => 2 [current_usage_crypto] => 1 [max_usage_crypto] => 2 [lock] => [message] => [error] => [active_member] => 0 [subscriber] => 0 [role] => [visitor_id] => 128511 [reason] => Usage under limits [method] => ) 1 and can accesss 1

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Market Recap

Happy New Year.

The market has been choppy recently, and the anticipated strong December performance did not materialize. While the S&P 500 fell 2.5% in December, the internal market performance was actually worse than the cap-weighted index as the equal-weighted index dropped 6.4%, with only 54% of S&P 500 stocks above their 200-day moving average. On one hand, year-end profit-taking may have played a role. On the other hand, the Fed’s hawkish cut in mid-December also impacted investor confidence. Even so, December’s weakness cannot overshadow the strong equity market in 2024. But this raises the question: how should we position ourselves for 2025?

First and foremost, the most important yet easily overlooked point is that the stock market and economic development do not suddenly change just because the calendar flips from 2024 to 2025. In other words, the market’s strength over the past two years won’t suddenly vanish simply because we are now in 2025.

Furthermore, the hawkish cut by the FOMC in December and the subsequent market reaction were admittedly disappointing. However, the real question is: has the macro landscape fundamentally changed? While the Fed did revise down its projected rate-cut path (fewer cuts), we do hold a contrarian view from the consensus that we believe fewer cuts are in fact better. Why?

• Fewer cuts indicate that the economic engine remains strong, reducing the need for the Fed to rescue the economy or the labor market by cutting rates.
• Fewer cuts mean a longer cutting cycle, which can provide sustained support to the market.

Regarding the FOMC members’ concerns about inflation, our base case remains that we do not expect inflation to resurge. As we’ve noted before, the current inflation rate remains above the Fed’s 2% target, primarily driven by housing and car insurance, both of which are lagging due to their statistical design. The recent uptick in used car prices is largely attributable to hurricanes. Beyond these factors, it is difficult to identify structural drivers that could cause inflation to resurge.

Some investors (and even FOMC members) worry that the incoming administration and its upcoming tariff policies might reignite inflation. However, we believe it is too early to draw conclusions. First, the specifics of tariff policies remain unclear, with speculation from various sides—for example, a recent Washington Post article suggested the top aides of president-elect were exploring tariff policies that would only cover critical imports, but this was quickly denied by Trump himself. At the end of the day, as Tom noted, Trump’s reelection largely stemmed from public dissatisfaction with rising prices in recent years, making it hard to imagine he would tolerate a resurgence of inflation under his watch, especially if caused by his own policies.

In summary, we believe the U.S. economy remains strong, macro tailwinds are intact, and both the Fed and the incoming administration are supportive of further economic growth aka two “puts” make a right (Trump put + Fed put).

Sector Ratings
The annual outlook is one of the biggest updates to sector ratings each year, and this year is no exception.

On the Macro side, Tom upgraded:

• Communication Services Neutral → Overweight: bullish on broader technology generally).
• Utilities Underweight → Neutral: incrementally benefiting from AI-driven grid/power demand and falling rates

And he downgraded:

• Energy Overweight → Neutral: if the Trump Administration is focused on keeping oil prices low and reducing global geopolitical risks, energy stocks may struggle to deliver significant upside
• Healthcare Overweight → Neutral: Trump’s healthcare policies might negatively impact this sector, though deregulation could have a positive effect, resulting in a neutral stance overall

On the Technical side, Mark upgraded:

• Discretionary Neutral → Overweight: technical strength, breaking out of a very lengthy downtrend

Mark downgraded:

• Real Estate Overweight → Neutral: the long-term downtrend remains intact on a relative basis despite the short-term rally
• Basic Materials Neutral → Underweight: commodity prices could face pressure especially the back half of 2025
• Healthcare Neutral → Underweight: generally unfavored defensive groups; while healthcare might recover over the next 3–6 months, Mark is skeptical that intermediate-term strength could persist

Currently, Tom and Mark align on 6 sectors out of the 11:

Sectors Overweighted by both Tom and Mark:

• Financials: Revived animal spirits, falling cost of capital, and the Fed entering a cutting cycle could boost economic activities like M&A and IPOs in 2025, benefiting investment banking. Easing financial conditions might especially help regional banks, which have lagged behind large banks since summer. Additionally, large banks could benefit from the deregulation agenda of the incoming administration. From a technical perspective, the equally weighted Financials have outperformed the equally weighted S&P 500 since 2023. Breaking out of the downtrend since 2019 is constructive.
• Industrials: The ISM Manufacturing PMI has remained below the boom-bust level of 50 for nearly the past 24 months, disconnecting from strong GDP growth. Tight financial conditions and Fed policy have hurt the manufacturing/industrial segment of economy. With easing conditions, industrials stand to benefit from lower borrowing costs for investment and production. Technically, Mark sees Industrials could be one of the best-performing sectors this year, given its rally to multi-year highs relative to the S&P 500 and the breakout of the Dow Jones Transportation Average since 2021, which boosts confidence in rails, freight, and trucking stocks. The equally weighted Industrials index has maintained its uptrend against the equally weighted S&P 500 since 2022.
• Technology: Macro tailwinds for technology remain strong, driven by global labor shortages and robust earnings growth. Despite recent weakness in software, cybersecurity names benefit from rising threats and a shift toward proactive strategies. PLTR, newly added to the S&P 500, is among the biggest winners of the DOGE initiative under the incoming administration.
• Discretionary: The equally weighted discretionary has been acting similar to financials, with its recent breakout ending a lengthy downtrend since early 2021. From a cap-weighted perspective, AMZN and TSLA together account for nearly 60% of the sector, making it difficult to underweight Discretionary while remaining bullish on AMZN and/or TSLA.

Sectors Neutral Rated by both Tom and Mark:
• Utilities
Sectors Underweighted by both Tom and Mark:
• Consumer Staples

In areas of disagreement, there are no significant divergences (one Overweight while the other Underweight):
• Communication Services and Real Estate: Overweight by Tom but Neutral by Mark.
• Basic Materials, Energy, and Healthcare: Neutral by Tom but Underweight by Mark.

These differences reflect variations in their investment horizons. Also, Mark tends to view sectors on an equally weighted basis.

Tactical Momentum Rankings
Since the Fed’s hawkish cut in December, some sectors have faced significant downward pressure:

• Consumer Staples and Real Estate have dropped to 9th and 10th place, respectively, in tactical momentum rankings.
• Basic Materials remains at the bottom. Since mid-October, it has fallen more than 15% at the worst, even as the broader market held up. While its downtrend seems to have stabilized, a rebound may take time.
• Healthcare and Energy, previously weak, have rebounded over the past three weeks. Notably, Energy has risen sharply from 9th to 5th in tactical momentum rankings.
• Comm Services and Technology have held up well, remaining in the top two positions, supported by the strong performance from the “Mag 7.”
• Industrials, similar to Financials, have seen their recent downtrend stabilize. In the latest tactical ranking, Industrials replaced Financials in the top three due to stronger DQM and fundamental scores.

Combining the changes in both strategic ratings and tactical rankings, our final recommended weightings have seen significant adjustments compared to last month:

• Discretionary: With Mark’s upgrade to OW, sector weighting increased by 0.6%.
• Industrials: primarily benefiting from the improvement in tactical rankings, sector weighting increased by 1.3%.
• Technology: Increased by 0.1% compared to last month, primarily due to its strong relative performance over the past month.
• Comm Services and Utilities: Sector weighting increased by 0.4% and 0.8%, respectively, due to Tom’s upgrade.
• Energy and Healthcare: Sector weighting increased by 1.9% and 1.5%, respectively, because of their improvement in tactical rankings.
• In contrast, Financials, Consumer Staples, and Real Estate decreased by 2.1%, 2.1%, and 2.2%, respectively, due to their decline in tactical momentum rankings.
• Since both Tom and Mark underweight Basic Materials as well as its weak momentum recently, we still recommend a 0% allocation to this sector.

Compared to the overall index, our largest Overweights are:
– Technology with additional weights of +2.5%,
– Industrials with additional weights of +2.1%,
– and Communication Services with additional weights of +1.9%.

We recommend overweighting Consumer Discretionary and Financials marginally higher than the overall index by 0.4%, while recommend market weightings for Energy, Healthcare, and Utilities.

Currently, we recommend a 0% allocation to Basic Materials and Real Estate. For Consumer Staples, we recommend a reduced weighting of -4.1% compared to the 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.

ETF Picks
Over the past period, following the broader risk-off in second half of December after the FOMC rate decision, all 5 of our ETF picks underperformed the market.

While most of the theses remain intact, we decided to replace some with technically more favorable options.

• IHAK 0.48% was replaced with CIBR 0.52% . While both are cybersecurity-focused ETFs, CIBR 0.52%  has a more concentrated portfolio. In addition to traditional software cybersecurity names, it also holds stocks like Broadcom (AVGO 1.92% ) and Cisco (CSCO -0.36% ).
• ARKW 2.65% was replaced with ARKQ 2.13% . ARKW 2.65%  and ARKQ 2.13%  are very similar, but ARKW 2.65%  has higher bitcoin/crypto exposure. As Mark suspects crypto to weaken in the first quarter of this year—despite still being constructive for the rest of the year—we decided to temporarily trim the exposure.

In addition, we added two ETFs with strong momentum (IWF 1.10%  and JETS -1.53% ) and removed FINX 0.90%  and MILN 1.11% .

The updated 5 ETF picks are:

1. ARK Autonomous Technology & Robotics ETF (ARKQ 2.13% )
2. iShares Russell 1000 Growth ETF (IWF 1.10% )
3. First Trust NASDAQ Cybersecurity ETF (CIBR 0.52% )
4. First Trust Cloud Computing ETF (SKYY 1.40% )
5. U.S. Global Jets ETF (JETS -1.53% )

Finally, we apologize for the delay in January’s sector allocation. The primary reason is that we wanted to wait for Mark to finalize his 2025 outlook and sector ratings before releasing it. If you missed his live webinar yesterday, you can click HERE to watch the replay. Additionally, Tom’s outlook from December is also available HERE for viewing.