During the first quarter of 2021, XLSR finished in positive territory for the quarter as the fund returned 1.72%. The fund finished the quarter with overweight positions in Financials, Materials, Communication Services and Technology.
Sector selection detracted from performance as negative contributions from Consumer Staples, Energy, Technology, Communication Services and Consumer Discretionary offset positive effects from Materials. Despite ranking well within our models throughout the second half of 2020, Consumer Staples began to underperform in January of this year, weighed down by large retailers and household products companies. Energy benefited from the continued reopening of major economies and the reflation thematic at the start of the year, but by March, news of spreading mutations of the COVID-19 virus weakened near-term enthusiasm and caused the sector to lag. Technology finished higher, but a combination of rising rates early in the quarter and overall procyclical rotation led to underperformance from the sector. Materials was held for most of the quarter and the sector was a top performer, aiding performance.
Portfolio Positioning and Outlook There are certainly pockets of equity markets that look frothy, some of which have cooled off during the back half of the first quarter. But from a high level perspective, the market internals of late appear to reflect more robust growth and optimism surrounding economic reopening. Our quantitative models continue to prefer equities as strong sentiment with respect to both earnings and sales expectations, coupled with positive momentum factors, outweigh stretched valuations and softening quality scores. Regionally, the US remains our favored region due to strong price momentum, positive macro scores and robust earnings and sales estimates, which offset unfavorable valuations.
Our favored equity sectors include a balance of those that skew towards growth (Technology and Communication Services) and some that rhyme with value (Financials, Energy and Materials).
The Technology sector continues to benefit from strong sales expectations and positive price momentum while looking attractive across all factors except value. The sector has had its struggles, particularly as real yields were rising sharply in February, but technology companies have a solid track record of delivering secular growth and a replay of February’s rate action without intervention from the Federal Reserve seems unlikely in our view. We also like the Communication Services sector, which had bucked the tech-related sell-off until the Archegos Capital hedge fund implosion in late March took some of the sector’s high flying names down with it. Nonetheless, with comparatively light debt loads and firm profits relative to total assets, the sector looks good from a quality standpoint as well as other factors like momentum and sentiment.
Financial stocks seem to be developing favorable seasonality around US Presidential election cycles but questions remain regarding the durability of their strong performance. More recently, relative stability in interest rates and a decision by the Federal Reserve not to extend supplementary leverage ratio (SLR) requirements took some of the wind out of bank stocks’ sails, but they still look good to us from an intermediate-term momentum perspective and across earnings and sales sentiment. Energy stocks have also mounted an impressive rally since their relative lows last November. The ongoing reflation thematic and recovery in demand (not to mention OPEC production cuts, stimulus bills and attempted port attacks) have boosted the outlook for Energy, which ranks well due to positive price momentum and strong value and sentiment readings. Materials round out our picks across the more cyclical sectors. With exposure to companies engaged in everything from mining to paint manufacturing, Materials appear attractive — particularly on valuation and momentum metrics.
Market Regime Forecasts The Market Regime Indicator (MRI) employs a quantitative framework and forward-looking market indicators, including equity- and currency-implied volatility, as well as credit spreads, to identify the current market risk environment. Tracking risk appetite shifts in the market cycle helps frame tactical asset allocation and volatility targets.
A Look at the MRI
Real Estate Investment Trust (REIT) Companies that own and operate commercial properties, such as office buildings and apartment complexes.
Overweight The weighting of a given security, industry or market sector that exceeds the weighting assigned that security, industry or sector in a relevant benchmark or benchmark portfolio.
Underweight The weighting of a given security, industry or market sector that is less than the weighting assigned that security, industry or sector in a relevant benchmark or benchmark portfolio.
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