The Thinking Behind Our Top Holdings

For client subscribers in particular, we think it's important to keep you abreast of why we're doing what we're doing within portfolios. 

Below are our latest summary narratives for our top 5 sector targets:


FINANCIALS (17% of equities) 6/23/18
While financials remain our fundamentally most attractive setup, after peaking with the rest of the market on January 26 (up 8% at the time), they have not been able to mount a sustainable advance, and remain 11% below the peak (down 3% on the year).

It’s not entirely clear what to attribute financials’ poor year-to-date performance to, I suspect, however, that it stems largely from geopolitical uncertainty and its potential impact on the global economy and, thus, the uncertain prospects for lending and higher interest rate (net interest margins) going forward; despite the fact that general conditions remain robustly positive in the face of present geopolitical concerns.

While macro conditions, regulatory trends, recent positive results of Fed stress tests and the prospects for hikes in dividends and share buybacks suggest that the second half of the year could see financials spring to the head of the pack, and, therefore, dictate that the sector remains our top weighting, we just cut our target to 17% (still our top weighting) to make room for other sectors that are demonstrating stronger trends as well as decent and/or improving fundamentals.

INDUSTRIALS (16% of equities) 6/23/18
Industrials are absolutely feeling the pain of the current trade environment. In that the Administration clearly aims to “protect” industrial players in key states, it virtually goes without saying that retaliation from our trading “partners” will be focused on the industrial sector (thus we recently dropped our target from 18% to a still high 16% of equities). Therefore, large positions in the index like Boeing and Caterpillar (both huge gainers until recently) are getting absolutely hammered and bringing the sector down with them. The 5 worst performing positions generate their revenue from foreign markets to the tune of 57%, 46%, 60%, 55% and 53% respectively. Yes, a trade war would be a very bad thing for U.S. industrial companies!

Our industrials ETF is currently down over 4% on the year.

Coming into the year we were quite bullish on the space based on very strong macro conditions (better than at the start of 2017 [which saw the sector up 21%]) and strong prospects for a much needed infrastructure plan in the U.S. . Not to mention ongoing huge infrastructure build outs in much of the rest of the world (Caterpillar is experiencing monthly sales increases in every region where they do business) – consider the foreign revenue figures I featured in paragraph 1.

While the stronger dollar poses a bit of a headwind for multinational industrial companies, it’s safe to say that this year’s dismal results are virtually all about the trade dispute(s). Therefore, if/when cooler heads prevail, as long as general conditions remain relatively bullish till then, prospects favor a huge rebound in the space. Thus, the sector remains our second highest target.


CONSUMER DISCRETIONARY (16% of equities) 6/23/18
Consumer discretionary stocks are having a banner year thus far (up 12.8%). Makes sense given the very healthy U.S. labor market and generally strong consumer sentiment readings. Both the fundamental backdrop and relatively strong technicals inspired us to recently increase our target weighting from 14% to 16%; now tied with industrials as our second largest weighting.

While names like Amazon and Netflix have large foreign revenue exposure (41% and 43% respectively), well, we’re talking Amazon and Netflix (two hugely popular global brands), many of the names in our discretionary sector ETF – such as Lowes, Home Depot, TJ Max, Target, Ross Stores – don’t (0%, 0%, 23%, 0% and 0% respectively). Thus, while a global trade war remains in the brewing stage – and macro conditions remain positive – consumer discretionary stocks are an attractive place to rotate to as traders reduce their industrials and materials positions.

I suspect that positive resolutions to present trade disputes could see the discretionary sector lose its leading position during the second half of the year, as traders take profits and rush their way back into the more trade sensitive sectors. That said, the sector is very economically sensitive and such an event would be economically bullish, so I expect we’ll maintain a relatively high weighting if/when cooler heads prevail on the trade front.


MATERIALS (15% of equities): 6/23/18
With their high correlation to industrials, materials are having a rough 2018 thus far as well (down 3.3%). While industrial materials are a no brainer retaliatory tariff target, as are chemicals (chemical companies are prominent in the materials index), other countries don’t really need to go there (but of course they will); as industrial companies need materials in the manufacturing process, chemicals are needed in plastics, construction materials, the ag industry (huge tariff target), and so on. The 5 worst performing positions generate their revenue from foreign markets to the tune of 70%, 60%, 46%, 75% and 17% respectively. Yes, a trade war would be a very bad thing for U.S. materials companies!

Like industrials we came into the year very bullish on the materials sector, for essentially the same reasons: Strong macro backdrop and huge prospects for U.S., and global infrastructure.

Per the sector’s heavy foreign revenue exposure, a stronger dollar is a headwind. However, as with industrials, materials company stocks’ poor year-to-date performance is mostly about the threat of a global trade war.

I expect a strong rebound if/when the players come to their senses (as long as general conditions remain bullish till then).

TECHNOLOGY (14% of equities): 6/23/18

While tech has given up the lead to discretionary on the year, it’s still up 11%, and, while consolidating of late, continues to sport a constructive-looking chart.

The fact that the sector has held up against the huge headwind coming from the Administration’s position on trade – and a stronger dollar, of late -- speaks to exceedingly strong reported earnings and outlooks for more of the same going forward.

Again, the recent consolidation comes amid the increasingly negative news on trade; the fact that the sector hasn’t used it as an excuse for a significant selloff suggests that if cooler heads soon prevail we could see yet another strong thrust higher as the year unfolds (thus our recent move from a 12% target to 14%). However, if the threat of trade war continues to increase (it’ll either increase or decrease; stasis is not a possibility on this issue), I do see the sector ultimately giving way to what could be huge profit taking. Such a market event, however, would likely bring the sides together to devise a working compromise.