U.S. Sector portfolio positioning intra-quarter update as of 02/13/2024

We continue to see two potential paths for the U.S. economy–either a slowdown with a risk of recession or a “soft landing” with moderate growth that extends the economic cycle. Given ongoing resilience of some economic data and potential for monetary policy easing, we have made portfolio adjustments to modestly increase expected economic sensitivity and take advantage of opportunities and challenges we see in specific areas of the market.

February 13, 2024

ACTIONS and OVERVIEW:

Added new allocation to Financials sector

• Added new Financials sector ETF holding

Reduced late-phase sector exposure

• Trimmed existing Consumer Staples sector ETF holding

Portfolio rebalance

We have added an allocation to the Financials sector, which we believe should benefit from easing monetary conditions, continued economic growth, increased capital markets activity, and secular trends such as the shift to digital payments.  We continue to avoid other early-phase, economically sensitive sectors, as we believe a reacceleration to sustained above-trend economic growth is highly unlikely at this point in the cycle.  At the same time, we reduced our overweight of the Consumer Staples sector, where we see specific risk to earnings growth and valuations in the current disinflationary environment, but we retain an overweight of late-phase, defensive U.S. sectors in aggregate.

We also took this opportunity to rebalance portfolios.

UPDATE DETAIL:

Added new allocation to Financials sector

• Continued economic growth, in addition to prospects for easier monetary policy, could introduce potential tailwinds for the Financials sector.
• While near-term earnings expectations for banks (approx. 25% of sector market cap.) are subdued, we believe the prospect of lower interest rates, combined with the current strength of bank balance sheets (particularly among large banks) mitigates industry-specific risks that have weighed on bank earnings expectations and valuations.
• Similarly, we believe revenue and earnings in the Capital Markets industry are positioned to rebound following two years of weak dealmaking and underwriting activity that pushed industry earnings down more than 20%.
• We expect Financial Services, the largest Financials industry by market cap, should continue to benefit from secular growth trends for credit card and payments companies, and the Insurance industry should benefit from increasing premiums and a reversal of underwriting losses that followed the economic reopening.

Reduced late-phase sector exposure

• Moving to a smaller overweight of the Consumer Staples sector reflects the potential for continued growth in the U.S. economy and the relative opportunity we see in Financials.
• Consumer Staples is expected to see a slower pace of earnings growth in 2024 than other late-phase sectors, despite trading at a higher relative valuation.
• We see specific risks to earnings expectations in the Food and Beverage industries, where an expected rebound in volumes and above-average pricing could prove challenging in a disinflationary environment.
• Valuations for Consumer Staples industries where we see more favorable fundamentals (e.g., Distribution & Retail) have reached levels well above long-run averages, reducing the return potential we see going forward.