Market on edge: after the Fed's rate-cut bang - how to position your portfolio for what comes next

Market on edge: after the Fed’s rate-cut bang
how to position your portfolio for what comes next

This article is inspired by a thought-provoking piece from my colleague, who highlighted a crucial but often overlooked point: "Instead of trying to time recessions and figure out whether this rate cut cycle means doom and gloom, it is far more important to look at the portfolio and think about whether it has the right exposures in a falling policy rate environment." -> related reading: The Fed rate cut cycle starts with a bang.

This advice resonates deeply, as many investors tend to be heavily concentrated in a single sector, such as technology, which has been a dominant performer in recent years. However, overexposure to any one sector—whether it’s technology, mining, or financials—can be risky, especially when market conditions change. So, how do we take this strategic view and translate it into actionable steps for a typical investor? That’s what we’ll explore today.

The problem: overconcentration in one sector

When a portfolio is heavily concentrated in one sector, it can become vulnerable to downturns in that specific area. For example, technology stocks have performed exceptionally well, but if the tech sector faces challenges, an investor with high exposure may suffer significant losses. The same risk applies if you are overexposed to other sectors, like mining or financials. Diversification across different sectors can help mitigate these risks and create a more resilient portfolio.

The insight: diversify for a lower rate environment

Sectors like consumer discretionary, utilities, communication services, and energy tend to perform better when interest rates drop. Why? Because lower borrowing costs spur consumer spending, help businesses expand, and make dividends from utilities more attractive compared to lower-yielding bonds. By diversifying across these sectors, you can better position your portfolio to benefit from a range of economic conditions.

From theory to practice: how to adjust your portfolio

Let’s break down how you can act on these insights and ensure your portfolio is well-positioned:

Assess your current portfolio:

Check your sector exposure. Look beyond just stock names and consider your entire portfolio, including ETFs, mutual funds, and even options. Are you too focused on one sector?

Calculate your sector exposure:

Determine what percentage of your total portfolio is invested in each sector. For example, if you have $100,000 invested and $50,000 is in technology stocks, your technology exposure is 50%. Apply this to all sectors you’re invested in.

Set your target allocation:

Decide on a balanced allocation. For example:

• 20% technology (or any sector where you may be overexposed)
• 15% consumer discretionary
• 15% utilities
• 10% energy
• 10% communication services
• 30% other (bonds, cash, other sectors)

This is just an example and not financial advice. You should adjust these allocations based on your own views, financial goals, and risk profile.

Adjust your holdings:

If your allocation to a particular sector is too high (e.g., 50% in technology or mining), reduce your position in those stocks.
Reallocate to underrepresented sectors, such as consumer discretionary (companies like Disney or Nike) or sector-specific ETFs (e.g., XLY for consumer discretionary, XLU for utilities).

Consider sector-specific ETFs:

For easy diversification, use ETFs that target the sectors you want to increase exposure to. This allows you to diversify without having to pick individual stocks. Here are some of the most commonly used sector ETFs:

• XLK (Technology Select Sector SPDR Fund): Provides exposure to large U.S. technology companies like Apple and Microsoft.
• XLY (Consumer Discretionary Select Sector SPDR Fund): Focuses on companies that sell non-essential goods and services, such as Amazon and Nike.
• XLU (Utilities Select Sector SPDR Fund): Offers exposure to U.S. utility companies, providing stable dividends and lower volatility.
• XLE (Energy Select Sector SPDR Fund): Tracks major U.S. energy companies, including ExxonMobil and Chevron, and is sensitive to changes in oil prices.
• XLF (Financial Select Sector SPDR Fund): Invests in U.S. financial firms like banks and insurance companies, including JPMorgan Chase and Bank of America.
• XLP (Consumer Staples Select Sector SPDR Fund): Covers companies that produce essential goods, such as Procter & Gamble and Coca-Cola.
• XLV (Health Care Select Sector SPDR Fund): Focuses on U.S. health care companies, including pharmaceuticals and health services like Johnson & Johnson.
• XLC (Communication Services Select Sector SPDR Fund): Includes companies in the communication services sector, like Alphabet (Google) and Facebook.
• XLI (Industrial Select Sector SPDR Fund): Provides exposure to industrial stocks, such as Boeing and Honeywell.
• XLRE (Real Estate Select Sector SPDR Fund): Focuses on real estate investment trusts (REITs), providing exposure to the real estate sector.

These ETFs allow you to gain broad exposure to specific sectors, helping you build a more diversified and balanced portfolio without the need to choose individual stocks.

Monitor and rebalance regularly:

This isn’t a one-and-done exercise. Check your portfolio every 6 to 12 months and adjust based on market movements and changing economic conditions.

Simplifying it: an example for all

Think of your portfolio like a garden. If you only plant one type of flower, like roses (technology stocks or any single sector), your garden might look beautiful now, but it becomes vulnerable to pests or bad weather. By planting a diverse range of flowers—some sunflowers (consumer discretionary), daisies (utilities), and tulips (communication services)—you ensure your garden remains vibrant and resilient throughout the seasons.

Conclusion: the takeaway

The key message from my colleague’s article is clear: don’t get caught up in predicting the next recession or market downturn. Instead, ensure your portfolio is well-balanced to thrive in any environment. By diversifying across different sectors and incorporating those that benefit from lower interest rates, you’ll be better positioned to capture gains and reduce risk, regardless of what the economy throws your way.