Please CLICK HERE to download the sector allocation report in PDF format.
Market Recap
Despite seasonality-based expectations to the contrary, the U.S. stock market ended September up, gaining 3.5%. The S&P 500 rose 7.8% in the third quarter and was up 13.7% year-to-date as of Sept. 30.
Perhaps the most noteworthy macroeconomic event in September for stock investors was the Federal Open Market Committee (FOMC) meeting on Sept. 17. As widely expected, the Federal Reserve chose to cut rates by 25 bps.
We anticipate that this was the start of an easing cycle, rather than a “one and done” cut. As the Fed begins to ease, this should:
- boost monetary liquidity, which is good for asset prices
- make cash less attractive, which is risk-on
- reduce spread of mortgage rates to bonds, thus boosting housing
A Fed easing cycle is also likely to boost CEO and business confidence, allowing the ISM Purchasing Managers’ Index (PMI) to move above 50. Typically, this is accompanied by improved hiring. As we discuss below, this is something the Fed would like to see.
The labor market
The Fed’s decision to cut rates reflects a growing and understandable concern about the health of the U.S. labor market. At the beginning of September, weekly jobless claims briefly touched their highest point since October 2021. Then on Sept. 9, the Bureau of Labor Statistics released an unusually large annual revision to hiring numbers, lowering the previously reported figure of jobs created in the U.S. in 12 months up to March 31, 2025 by 911,000.
The size of the revision means that over the past year, the U.S. labor market has been significantly less healthy than had been previously believed. Thus, as FOMC officials noted in the official policy statement on Sept. 17, “downside risks to employment have risen.”
In our view, the Fed made the correct decision. Relative to available workers, the latest Job Openings Absolute Level (JOLTS) numbers are still below their pre-pandemic levels.
The rise of AI looks likely to exacerbate the unemployment situation, both now and over the long term. The Federal Reserve of St. Louis recently published a report that assessed the exposure rate of AI across industries, then examined the changes in their respective unemployment rates. What they found was that the industries with higher exposure of AI also had a higher rise in unemployment.
Researchers suggest that this means we might be witnessing the early stages of AI-driven job displacement. While we are inclined to agree that this points to downside in the future for the job market, it also strengthens the arguments for the Fed to lean dovish.
Is there an AI bubble?
Despite the growing impact of AI, many investors have been asking us whether we have reached “peak AI” — mainly because many of the largest MAG7/AI names have seen profit taking recently. To me, such questions themselves are healthy to see. We are hardly at peaks when investors start to question their conviction at every pullback.
On Sept. 9, Oracle reported results after the close, disclosing unexpectedly strong bookings (remaining performance obligations, or RPOs) of $455 billion. The subsequent surge in Oracle shares helped reinforce for us that the AI infrastructure story remains intact.
However, the best barometer of this, in my view, is Nvidia (NVDA). When you look at Nvidia, the forward PE ratio is really at the midpoint of its five-year range. Nvidia is arguably the scarcest company today. They make a chip that every single AI company needs. Yet, its forward P/E is only 29.6X, while Costco (COST) and Walmart (WMT) are trading around 41X and 34X. Until Nvidia’s forward P/E is 50X or so, it is hard to argue Nvidia is a bubble.
Looking forward
We are entering the fourth quarter of the year, which has historically brought strong seasonal tailwinds that help to boost stocks higher. Since 1950, the median gain from October through December has been 4.9%, with a win ratio of 81% (n=75). This implies an S&P 500 level of 7,050.
Two of these precedents are particularly relevant, as they are similar . Just like this year, in 1998 and 2024, the Fed was on a pause for the rest of the year before cutting rates in September. In those two cases, the average gain from October through year-end was 13.8%. A similar gain this year would imply an even year-end level of 7,750 for the S&P 500.
In summary, our view is that a strong seasonal tailwind is underway, with the possibility of upside that could exceed that implied by our base-case year-end target.
Strategic Sector Ratings
For the strategic sector ratings, the primary change comes from Mark’s downgrade of Consumer Staples from Neutral to Underweight.
Consumer Staples was upgraded by Mark from Underweight to Neutral back in August for two reasons:
- The sector showed technical improvement and signs of stabilization, both in absolute terms and relative to the S&P 500.
- As a defensive play, Consumer Staples was favored given that August and September have historically been challenging months during the first year of a presidential cycle.
However, over the past two months, Consumer Staples has made little progress. The weakness has been broad-based, even though the largest company in the sector, WMT, has actually performed well. In both absolute and relative terms, and in both cap-weighted and equal-weighted measures, the sector has resumed its downtrend. Mark does believe we could see a rebound in Consumer Staples in November; however, until then, it makes more sense to downgrade it to Underweight given its recent weakness.
After Mark’s downgrade of Consumer Staples, Tom and Mark now share the same ratings for 8 of the 11 GICS sectors.
- Overweight by both: Consumer Discretionary, Industrials, Technology, Communication Services, Financials
- Neutral by both: Basic Materials, Healthcare
- Underweight by both: Consumer Staples
The only three sectors with different views are:
- Real Estate: Overweight (Tom), Neutral (Mark)
- Energy: Neutral (Tom), Underweight (Mark)
- Utilities: Neutral (Tom), Overweight (Mark)
Tactical Ranking
Compared with last month, there have been significant shifts in the tactical sector ranking.
- Technology has undoubtedly advanced to the top spot. Over the past few weeks, the overall market has been carried higher by technology and AI-related stocks.
- Industrials and Utilities have also benefited from the broader AI trade trend, climbing sharply in the ranking from #8 and #9 to #2 and #3, respectively.
- Meanwhile, the previous top 3, Communication Services, Financials, and Consumer Discretionary, have each slipped modestly.
- Given the ongoing rate-cutting backdrop, both Discretionary and Financials should continue to perform well, so this temporary and marginal decline is not a major concern.
- Similarly, Communication Services peaked around mid-September, with META, along with entertainment and traditional telecom stocks, dragging down overall performance. However, considering that nearly 30% of the sector’s weight is concentrated in the two giants, META and GOOGL, the recent dip in tactical ranking should not be viewed as a reason to underweight the sector.
- Materials and Real Estate have fallen to the bottom 3. Although precious metals like gold have reached new highs amid a weaker dollar, other segments within the sector (such as Chemicals) have performed poorly. A bullish view on precious metals alone is not sufficient to justify strength across the entire sector.
- Consumer Staples currently rank at the very bottom among all sectors. The group has lagged across nearly all metrics. Rather than breaking out of its downtrend, the sector has instead accelerated lower. While some idiosyncratic factors, such as the current administration’s advisory on Tylenol use during pregnancy that triggered a sharp drop in KVUE, have contributed to the weakness, the sector as a whole still needs to stabilize before any potential rebound.
Compared with last month, Sectors with weight increases are:
- Utilities +3.7%
- Technology +3.1%
- Energy +1.9%
- Industrials +1.6%
- Healthcare +0.1%
Sectors with weight decreases are:
- Communication Services –2.4%
- Financials –2.4%
- Consumer Discretionary –2.2%
- Real Estate –1.7%
- Materials –1.6%
- Consumer Staples –0.2%
Relative to the benchmark index:
- We remain heavily overweight in non-commodity cyclical sectors, as well as Utilities, driven by rising energy and infrastructure demand from AI and data centers.
- We are recommending underweight positions in three sectors — Consumer Staples, Real Estate, and Basic Materials.
- We currently maintain a market weight stance on Healthcare and Energy.
*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.
Updated ETF Picks
Over the past month, our recommended ETFs gained an average of 17.8%, outperforming S&P 500 by roughly 1,380 bps. This strong outperformance was mainly driven by three ETFs:
- Benefiting from the broad strength in the crypto market in September, IBLC rallied 46% since the last sector allocation report.
- Following that, the Clean Energy ETF and the Lithium & Battery ETF advanced 28.2% and 17.9%, respectively.
Biotech also performed well, especially after President Trump and Pfizer reached a drug pricing deal last week.
The only underperformer was the Home Construction ETF. After rallying more than 35% from the mid-June low, homebuilders saw about a 10% pullback during September — partly due to technical consolidation, and partly because Core & Main, a key water and sewer supplier, noted softer residential demand and higher expenses in its earnings report, adding pressure to builder stocks.
In October, Mark decided to replace IBB and ITB with ARKQ and BOTZ. AI and Robotics remain one of the market’s dominant narratives. Capex spending continues to fuel not only equity performance but also broader economic strength. Today’s AMD news is a good example, reaffirming that the AI trade remains intact.
Updated Five ETF Picks:
- ARK Autonomous Technology & Robotics ETF (ARKQ)
- Global X Lithium & Battery Tech ETF (LIT)
- iShares Blockchain and Tech ETF (IBLC)
- Global X Robotics & Artificial Intelligence ETF (BOTZ)
- Invesco WilderHill Clean Energy ETF (PBW)
