Treasuries, Korea, Buffer ETFs, Cozy Real Estate

Look to Unloved Sectors 

The idea:
The US equity market has had a tremendous run in 2023, but much of the rally has been concentrated in the Magnificent Seven. In our mind, that means investors don’t have to sit out the equity market altogether but can instead rotate into sectors and countries that haven’t seen as much investor enthusiasm. These markets are generally cyclical, though, and carry no shortage of risk, particularly in the event a recession emerges. For that reason, we recommend pairing the exposure with a side of short-dated bonds.

The strategy:
In the US, we’re most enthused about banks, materials, and master-limited partnerships (MLPs). (Note: there’s decent levels of small-cap exposure in these sectors) Of the three, banks likely face the greatest fundamental risk, given concerns about asset/liability mismatch and commercial real estate exposure. Our analysis suggests the selloff as the banking crisis emerged priced in at least some of that risk.

In materials, the sector has improved in quality while our proprietary valuation framework suggests it’s a relative buy next to pricier US sectors. MLPs are also a relative value story and have shown fundamental improvement through greater capital discipline, with the added benefit of a healthy yield.

There are attractive opportunities overseas as well, in emerging markets and select European markets like energy. Non-US exposure comes with currency diversification — not a bad thing should the Federal Reserve begin to lower rates. However, these markets aren’t meaningfully less cyclical than banks, materials, and MLPs, and court their own economic risks, particularly if there’s a global slowdown.

To offset concerns around added cyclical exposure, a short-duration Treasury bucket — maturities of two years and under — can give investors a yield of around 5% and the ability to opportunistically add to the cyclical exposure should volatility emerge.

The big picture:
In 2022, valuations were improving but economic uncertainty was mounting. In 2023, much of that fear has dissipated, but valuations aren’t screamingly cheap. Our emphasis is robustness rather than market-timing or momentum.