Equities

Banks mostly surprised with earnings beats for Q2-2023, lifting broad and regional bank stocks alike. Despite prevailing macro headwinds, banks are cheap and oversold, supported by better-than-expected earnings. A broadening of the rally supports further upside to the industry. Move to overweight banks over a tactical horizon.

Cybersecurity costs continue to climb, which compels companies and governments alike to increase spending on cybersecurity to bolster digital protection. This will boost sales of companies in the cybersecurity ecosystem. While performance of the cybersecurity cohort may be volatile over a short investment horizon, it has significant long-term investment potential. Cybersecurity is a USES strategic investment theme.

Both EV and Green Energy themes still hold strategic promise for investors, posing large upside, despite prevailing macro headwinds. While both themes have yet to claw back their pandemic peaks, a broadening of the rally supports a run for both, even in the face of high valuations.

Q2-2023 is expected to be a bookend quarter to the earnings contraction of the past year, and hopefully, will open a new chapter. Much of that potential positive news is already priced as the market has been looking past earnings contraction. However, with valuations stretched, the market is fragile and the reaction to disappointment will be brutal.

Special Report

We build a four-stage business cycle framework based on economic growth and capacity utilization, and then analyze historical returns for most major asset allocation decisions for each stage. Given that we are in the early recession stage (negative growth coupled and an overheated economy), our framework recommends a defensive positioning across all asset classes.

In June, the rally gained momentum and broadened due to positive economic data, particularly in the housing market. We expect cheaper cyclical sectors and styles to mark a change in leadership as the rally broadens, helped on by excess cash on the sidelines. We upgrade Banks to equal-weight, and Homebuilders to overweight. The rally may continue but a soft landing continues to be elusive - disappointment may be in store.

Momentum, high cash balances, FOMO, and expectations of soft landing drive the market higher. This rally may continue for a while, but macroeconomic headwinds are intensifying and will eventually derail the rally. It is too early to celebrate victory.

Investors are still cautious and have significant cash that needs to be put to work. Trickle-down of it into the US equity market may extend the rally. Overly bearish futures positioning is also a strong contrarian indicator. Disinflation is good for real earnings growth, and imminent earnings rebound may add support for equities.

The S&P 500 performance was flat in May if not for the strong performance of a small cohort of mega-caps, aided by exposure to AI. Earnings and sales growth are contracting but analysts expect a rebound into a yearend, which is already priced in. Yet, inflation is still elevated, and the job market is stubbornly tight – rates will stay much higher for longer, eventually ending the party. Until then, the lopsided equity rally may continue.

The semiconductor industry is at the epicenter of the AI frenzy, which even with all the hallmarks of a bubble, may last for months. There are also early signs of a turnaround in demand for more conventional chips. As such, it no longer pays to be underweight in the sector. But the sector is too expansive to shift our positioning to an overweight. This is not a trade to “be a hero” - we upgrade the sector positioning to neutral.