PWA 2020 Year-End Letter Part Six: Sectors

In this part six of our year-end letter I’ll present an overview of how we see the U.S. equity market setup on a sector by sector basis.

First, let’s take a look at how the major sectors stack up in terms of their weightings within the S&P 500 Index (compliments of Bespoke Investment Group).

Note where I added the red dots around the tech sector. Yep, haven’t seen this kind of concentration there since 1999. By the way, the sector peaked in March 2000, then bottomed in March 2003, ~82% below (not a typo!)…

Also note that only one other sector experienced a stint above a 20% (darker green shade) weighting over the past 30 years… Yep, that was financials during the runup to the Great Financial Crisis of 2008… Financials actually peaked in May 2007, then bottomed in March 2009, ~85% below (eh hem, not a typo!)…  
I.e., our hedging portfolios these days has zero to do with bent or bias… It’s all about data, human nature, and history…
If you care about fundamentals, as we do, you care about things such as relative (to history and to competing sectors) valuations, as well as the macro setup (which captures everything  from general economic conditions to earnings prospects to interest rates to currency dynamics, and so on).

Let’s take a brief look at each sector…


In terms of earnings prospects, my how you gotta love tech!

Of course the question is, to what extent does the sector’s (aggregate of the stocks in the sector) current price already discount its earning’s prospects going forward?

At 29 times next year’s projected earnings, well, tech looks plenty rich right here. 

Per the following graph, while the forward price-to-earnings (p/e) peak in ’00 is a ways off, it’s presently sitting at levels not seen since that late ’90s early ’00s experience:

Now we’ll add actual price action into the mix:

Again, that’s a roughly 82% peak to trough hit during that period.

Now, we absolutely get it, the world’s changed much since 1999, and tech — as my son/partner Nick is fond of reminding the old man — is a staple these days.


Yes, we’re aging — in fact, U.S. demographics are a not-small macro concern going forward — and, therefore, the healthcare sector has much to offer the patient long-term investor.

There’s also politics — read regulations, drug price controls, etc. — that pose headwinds to consider.

In terms of price relative to earnings expectations, healthcare’s a bit easier to stomach than tech these days:

Consumer Discretionary

If Wall Street’s right, once we’re all vaccinated pent up demand is going to blow the proverbial roof off of the economy, and the stock market to boot. 

If, on the other hand, my Japan analogy from Part Three at all reflects the current U.S. setup, there’s some risk in Wall Street’s euphoric assumptions.

In any event, per the sector’s price to earnings expectations, the market’s pricing in that Wall Street euphoria:

Communication Services

Considering the most heavily weighted companies in the index — Facebook, Google, Netflix, Disney and two positions we hold individually AT&T and Verizon — one could argue Nick’s tech-is-now-a-staple point with regard to the communications sector as well. And I totally agree, these companies are 100% essential and are here to stay.

That said, they’re presently rich in price relative to their prospective earnings, and 2021 is going to be a year of intense antitrust scrutiny toward the likes of Facebook and Google from, in particular, the U.S. and Europe. Whether or not that’ll, by itself, spell bad things for these stocks remains to be seen…


Banks look relatively cheap by a number of valuation metrics. 

One could argue that’s due to low net interest margins and/or the prospects for their loan books to sour once (if ever) government, and the Fed, step back from their campaign to keep companies afloat.

Volatile markets are particularly good for the big banks with their trading desks, as high volume means high transaction revenue. 

Also, while stocks are hot, so’s the IPO market. And, make no mistake, those who underwrite those issues get paid most handsomely! Ever wonder why Wall Street’s always so bullish on stocks?

While we definitely see promise in the sector going forward — so much so that we’re considering upping our weighting as we get into 2021 — we think the sector will likely face two serious headwinds over the longer-run.

One, as we’ve pointed out much lately, we’re 100% certain that the Fed will artificially suppress even the longer-end of the interest rate curve virtually as far as the eye can see. The massive debt bubble, and the need to keep the dollar at bay, will demand that they do
so, regardless of the rate of inflation going forward. 

That means low net interest margins (the difference between banks’ cost of money and the interest they receive when they lend it out) going forward, which is bad news for big lenders.

The other is a topic that will no doubt be prominently featured in much of what I write about over the next few years; the advent of sovereign digital currencies. 

In Part Five I made brief reference to China’s ambitions:

“China is on yet another tear when it comes to infrastructure spending within their own economy; gobbling up much of the world’s industrial commodities production in the process. Plus, with their “One Belt, One Road” initiative, they are rapidly expanding across the globe, financing infrastructure projects from East China through Southeast and South and Central Asia all the way to Europe.

And while there’s much to parse in this massive global outreach — including the potential to provide a huge springboard for China’s own digital currency, which some view as the most credible threat to the U.S. dollar’s global dominance going forward (a serious topic we’ll no doubt broach often and in detail in the months to come) — make no mistake, with regard to commodities demand, it’s big!”

Ironically, I came across an article last night in the South China Morning Post titled How China’s Digital Currency Will End Threat of US Dollar Trap.

Per the article, with a sovereign digital currency (the U.S. is on it, by the way, but China has a huge lead), who needs banks?

“Driven by latest blockchain technology, China’s digital currency does not require a bank account. This has huge poverty-relief potential for the unbanked poor across the globe.”

While, yes, we’re looking at further-down-the-road stuff here, I must say, relative to my expectations just a few months ago, clearly, it’s closer than I thought…

Relative to prospective earnings, financials look okay right here:


The industrials space has something to offer nearly every bull out there.

In it you capture the earth movers (think infrastructure), like Caterpillar, Cummins and Deere, but you also gain exposure to the package movers like UPS and FEDEX (and the rails), as well as the people movers, like United and American Airlines — and more

So, sure, we’ll be owning industrials going forward (currently 11% of our U.S. equities exposure).

Although, alas, like too much else in the market these days, their price to expected earnings reflects Wall Street’s, and main street’s (investor) for that matter, euphoria:

Consumer Staples

The consumer staples sector of course captures the companies whose wares are essential to our survival.

Well, depending on how you feel about sugar, caffeine and snack foods in particular, perhaps not everything in the index is “essential” to our survival.

Top holdings include Procter and Gamble, Coca-Cola, Pepsi, Walmart, Costco and Colgate.

While we’ve trimmed them a bit this year, staples remain a decent-sized position in our core allocation (15% of U.S. equities target). 

We’ll likely pull from them a bit more as we further express our go-forward thesis in the coming weeks.

Valuation-wise, they’re not cheap either:


Now, whether you’re into sugar and caffeine or not, utilities are indeed essential to your survival.

As a sector, folks typically buy them for their safety, and their yield (currently 3.38%).

Which means they can be relatively solid vs cyclical sectors when investors panic, and, thus, can underperform when they’re giddy — and, being sensitive to prevailing interest rates, can lose ground when interest rates are on the rise.

We came into the year, as you know, concerned, thus utilities were right up there with our heaviest weightings. Since then we’ve cut them all the way down to just 8% of our U.S. equities exposure. 

And, like most other sectors these days, they’re not super cheap right here either:


While materials are also not cheap on a price to forward earnings basis, we like them a lot nevertheless.

In a nutshell, as I noted in Part Five, the world’s in building mode, so of course we want to own materials (we hold the base metals commodities ETF), and the companies that produce them (the materials stock ETF).

We came into the year with materials stocks at 8% of our U.S equities target, we’re now at 15.5%.

And, while, again, we like them a lot going forward, they could be cheaper:

Real Estate (REITs)

Real Estate Investment Trusts (REITs) come in different shapes (multi-family housing, senior living, healthcare, shopping malls, offices, storage, mortgage, etc.). In lieu of what we viewed as safer/more attractive sectors we took them down from 10% to start the year to zero presently.

XLRE, the S&P REIT-tracking ETF still remains nearly 14% below its pre-Covid peak.

While we’ll definitely keep an open mind, and will no doubt own the space again in the future, at present we’re not eyeballing more than maybe a small allocation…

Valuation-wise, we’re uninspired:

Lastly, Energy

The energy space has definitely grown on us these past few months. So much so that we’ve taken it from 5.7% of U.S. equities in August up to 12.5% today. 

We may very well be adding a bit more in the coming weeks…

Here are two references to our thinking from our November blog posts:
11/9: Within U.S. equities, we’re about to cut utilities by 30% and add to energy stocks with the proceeds… Within our non-US exposure, we’re cutting Europe by 22% and adding to emerging mkts with the proceeds…

The energy exposure gives us more tilt toward commodities (and, btw, materials is now our largest U.S. sector target), plus it’s off ~50% from its peak, and has seen tremendous capacity destruction the past few years…

I suspect people will think a Biden win is negative for fossil fuels, but they’re missing the fact that Trump was opening up public land for drilling.. Of course Biden will squash that in a hurry…

Again, lack of capacity, with any amount of demand coming back likely bodes well for the sector (via, for example, the price of oil) in the months/years to come…

11/24: Adding a bit more energy exposure (cutting some utilities exposure) by introducing OIH to the core mix. OIH is an energy ETF that focuses specifically on oil and gas service companies, as opposed to the producers themselves.

This is a nice complement to XLE, as it’s concentrated in 25 names that will be instrumental as companies scramble to bring capacity back on line as folks, and businesses, become more mobile post-covid (with the attendant rise in oil and gas prices). A substantial infrastructure bill, if, as expected, is passed in 2021, will of course add upward pressure to the space as well.

Now, don’t get too freaked out by this forward p/e chart. Apparently there’s been zero guidance offered since mid-year:

Perhaps we should look at this one on a price-to-book-value basis:

That’s better!

Well, I couldn’t quite get to the finish line with part six… 

Still need to dig deeper into what a post-Covid economy may hold in store, as well as the unique setup(s) outside U.S. borders...

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