S&P: A Fed-Fueled Sector Shift

The central bank's interest-rate cut was a catalyst for big changes by S&P Equity Strategy

In light of what Standard & Poor's Chief Economist David Wyss characterized as a "surprising" move by the U.S. Federal Reserve on September 18, S&P's Investment Policy Committee upped its year-end target for the S&P 500 index to 1,560, from a previous forecast of 1,510. We now expect the S&P 500 to deliver full-year gains of 10%, not including dividends.

On September 18, the central bank cut both the Fed funds rate and the discount rate by 50 basis points each. The Fed funds rate is now 4.75%, down from 5.25% before the move. The move was bigger than many had expected; S&P Economics anticipated a reduction to 5% at the September meeting, followed by two more cuts later in the year.

To take advantage of the changed market circumstances, S&P Equity Strategy made several sector allocation recommendation changes. Specifically, technology is now overweight (previously marketweight), and materials and utilities are now marketweight (previously underweight). (See table below.)

"Our target level increase and suggested rotation to more cyclical sectors does not imply that we believe investors should embrace history (and hence all cyclical sectors) without question," says Sam Stovall, S&P's chief investment strategist. "We still believe there are many possible pitfalls in the financial sector in general and the autos and housing groups in particular."

At the same time, S&P Equity Strategy reduced its allocation recommendation on health care to marketweight.

The two sectors that historically perform the best in the six months after an initial Fed rate cut are technology and consumer discretionary. However, S&P Equity Strategy still advises an underweight allocation to consumer discretionary, specifically citing concerns about housing and auto sales.

S&P Economics says the Fed move reduces the risk of recession in the next 12 months to a 33% chance, down from a previous forecast of 40%. Wyss expects another Fed rate cut, to 4.5%, in October.

S&P's Sector Recommendations
Sector ETF Recommendation Actual Weighting (%) Rec. Weighting (%)
Consumer Discretionary XLY Underweight 9.5 8.5
Consumer Staples XPL Marketweight 9.5 9.5
Energy XLE Overweight 11.5 12.5
Financial Services XLF Marketweight 19.9 19.5
Health Care XLV Marketweight 11.7 11.5
Industrials XLI Marketweight 11.4 11.5
Information Technology XLK Overweight 16.1 17.0
Materials XLB Marketweight 3.1 3.0
Telecom. Services IYZ Marketweight 3.7 3.5
Utilities XLU Marketweight 3.5 3.5
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