Repositioning Portfolios for Moderating Consumer Strength and Ongoing Financial Turbulence
Outside of the shockingly fast failures of Silicon Valley and Signature Banks, the strength with which the Technology and Communication Services sectors finished 1Q23 undoubtedly defines the biggest surprise for equity markets for the first three months of the year. Led by a meteoric 81.9% rise from Meta (aka Facebook) to start the year, the Communication Services Select Sector SPDR (XLC) exchange traded fund (ETF) moved 23.1% higher for 2023 through April 17th. Similarly, NVIDIA’s (NVDA) artificial intelligence chip-driven investor fury led to an 84.8% rise in its shares and a 19.8% appreciation for the Vanguard Information Technology (VGT) ETF.
Alas, we do not foresee such tailwinds persisting for either of these sectors as we progress through 2023. In response to this view, we remain Underweight Tech, as you can see in the following table. We add an Underweight to Financials to our sector views as well. Offsetting these lower-than-benchmark weightings, we maintain Overweight the Industrials and Materials sectors. We also see fit to upgrade Utilities to Equalweight, which only translates to a 2.8% weighting, or roughly a single-stock holding in the Solyco Wealth Model Portfolios.
|Symbol||Description||Russell 3000 Weighting||Previous Solyco Wealth Weighting||New Solyco Wealth Weighting||SW Diff vs. R3000|
|VGT||Vanguard Information Technology ETF||24.1%||21.1%||21.1%||-3.0%|
|XLV||Health Care Select Sector SPDR® ETF||14.5%||14.7%||14.5%||0.0%|
|XLF||Financial Select Sector SPDR® ETF||13.5%||11.7%||10.0%||-3.5%|
|XLY||Consumer Discret Sel Sect SPDR® ETF||10.1%||11.3%||10.1%||0.0%|
|XLI||Industrial Select Sector SPDR® ETF||9.7%||13.7%||13.7%||4.0%|
|XLC||Communication Services Sel Sect SPDR® ETF||7.7%||7.5%||7.7%||0.0%|
|XLP||Consumer Staples Select Sector SPDR® ETF||6.6%||6.1%||6.6%||0.0%|
|XLE||Energy Select Sector SPDR® ETF||4.9%||5.3%||4.9%||0.0%|
|VNQ||Vanguard Real Estate ETF||3.0%||3.0%||3.0%||3.0%|
|XLB||Materials Select Sector SPDR® ETF||2.9%||5.6%||5.6%||2.7%|
|XLU||Utilities Select Sector SPDR® ETF||2.8%||0.0%||2.8%||0.0%|
A couple vagaries inherent in how the index masters construct and populate these sector indexes bear mention, in our view. First, our Overweight to Industrials more reflects our affinity for Airlines and expectations for an ongoing rebound in air travel and the fact that this sub-category resides in the Industrials index rather than the more logical, in our opinion, Consumer Discretionary sector. Any sector-focused discussion also would be misleading these days without a quick mention of the massive degree of concentration plaguing several of these indexes. For instance, Amazon and Tesla recently composed approximately 40% of the Consumer Discretionary, as do Apple and Microsoft for the Tech index and Meta and Google for the Communication Services index.
Thoughts underpinning our sector positioning as we move through 1Q23 earnings season and look to the balance of the year include:
- Moderating US consumer spending strength brought on by:
- Weakening wage growth
- Exhausting influences of inflation-era prices on pandemic savings
- Regressing rates of experience consumption to pre-COVID levels
- Stagnating advertising markets and rates
- Increasing funding costs for financial institutions amid slow- to no-growth US economy
- Onshoring and infrastructure improvements driving modest demand growth for related Industrial and Materials investments.
The fact that on a price-to-earnings (P/E) basis Tech already trades at a rich, 20%+ premium to the 5- and 10-year average P/E multiples for the sector amidst data provider FactSet’s expectations for a year-over-year drop in earnings on almost flat sales informs our Underweight to that sector. Certainly these reserved financial expectations leave room for upside, but we argue that the P/E premium likely already reflect this potential. As for our Materials Overweight vis-à-vis the relatively ugly picture portrayed for the sector in the table below, previously mentioned index-construction quirks and our specific securities selectins within that sector drive our view. Specifically, significantly more conservative 2023 EPS expectations for fertilizer and metals producers as compared specialty chemicals and lithium producers define the differences in our positionings.
|Symbol||Description||2023 Y/Y EPS View||2023 Y/Y Sales View||2023 P/E||5Y Avg. P/E||10Y Avg. P/E|
|VGT||Vanguard Information Technology ETF||-0.3%||1.3%||24.5x||22.1x||19.0x|
|XLV||Health Care Select Sector SPDR® ETF||-9.0%||2.7%||17.8x||16.0x||16.0x|
|XLF||Financial Select Sector SPDR® ETF||9.5%||8.0%||13.1x||13.0x||13.0x|
|XLY||Consumer Discret Sel Sect SPDR® ETF||25.0%||5.3%||24.5x||26.8x||22.5x|
|XLI||Industrial Select Sector SPDR® ETF||11.0%||3.8%||18.3x||19.3x||17.7x|
|XLC||Communication Services Sel Sect SPDR® ETF||15.0%||3.8%||20.4x||19.1x||15.7x|
|XLP||Consumer Staples Select Sector SPDR® ETF||2.5%||3.8%||20.4x||19.7x||19.3x|
|XLE||Energy Select Sector SPDR® ETF||-22.0%||-11.4%||10.9x||3.4x||15.7x|
|VNQ||Vanguard Real Estate ETF||0.3%||5.3%||17.4x||19.5x||NM|
|XLB||Materials Select Sector SPDR® ETF||-16.0%||-3.4%||17.0x||17.1x||16.5x|
|XLU||Utilities Select Sector SPDR® ETF||7.5%||-3.6%||18.4x||18.6x||17.5x|