TMFC: Why Contrarian Strategies Outperform in Late-Cycle Markets

The U.S. economy is entering a precarious phase of its cycle, marked by slowing growth, elevated valuations, and a reliance on consensus-driven sectors. For investors, this is a critical moment to reassess risk exposure—particularly in funds like the Motley Fool 100 Index ETF (TMFC), which tracks large-cap growth stocks. In this article, we'll dissect how TMFC's heavy exposure to overvalued sectors aligns with late-cycle vulnerabilities and why contrarian strategies—shifting toward underfollowed opportunities—could be the smarter play.

Late-Cycle Dynamics: A Perfect Storm for Overvalued Consensus Plays

The U.S. economy is in a late-cycle slowdown, as evidenced by the Conference Board's Leading Economic Index (LEI) declining by 2.0% over six months ending April 2025. While the coincident and lagging indices remain stable, the LEI's “3Ds” framework (duration, depth, diffusion) signals weakening momentum. The Federal Reserve's revised GDP forecast of 1.6% for 2025 underscores the fragility of growth, particularly as tariffs and inflation pressures intensify.

In such an environment, consensus-driven sectors—like technology, which dominates TMFC's portfolio—face heightened risks. These sectors have been buoyed by valuation expansion (contributing ~50% of returns in 2024) rather than earnings growth. The P/E10 ratio for the S&P 500 hit 35.0 in May 2025, nearly double its historical average, while the TTM P/E ratio of 26.4 exceeds its 25-year average of 16x. This suggests investors are overpaying for growth in sectors like AI and cloud computing, which may struggle to deliver returns if economic headwinds materialize.

TMFC: A Case Study in Overexposure to Growth-at-Any-Cost

TMFC is a Large Cap Growth ETF, with 39.4% of its portfolio in the Information Technology sector, including top holdings like Microsoft (9.7%), NVIDIA (NVDA), and Apple (9.7%). While these names have fueled returns—delivering a 19.24% one-year gain as of June 2025—their dominance masks risks.

Key Issues with TMFC's Strategy:1. Valuation Misalignment: Tech stocks like NVIDIA trade at 34x forward P/E, relying on AI hype rather than consistent earnings. The fund's beta of 1.14 amplifies volatility, as seen in its -17% YTD drop in early 2025 amid concerns over Chinese AI competition.2. Earnings Growth Lag: Despite high valuations, earnings growth in TMFC's top holdings has been inconsistent. NVIDIA's Q1 2025 data center revenue rose only 8% YoY, far below the 30%+ growth priced into its stock. 3. Concentration Risk: The top 10 holdings account for 57% of assets, leaving TMFC vulnerable to sector-specific corrections.

Contrarian Opportunities: Where to Deploy Capital Instead

In late-cycle markets, contrarian strategies focus on underfollowed sectors with structural tailwinds and reasonable valuations. Here are three areas to consider:

1. Utilities (XLU):

• Why: Utilities offer stable cash flows and low volatility, critical in uncertain environments. The sector's P/E of 18x (vs. Tech's 34x) and 3.5% dividend yield provide a cushion against rate cuts and inflation.
• Risk: Limited upside in a robust economy, but resilience in downturns.

2. Industrials (XLI):

• Why: Industrials are priced for pessimism, with a P/E of 16x and exposure to infrastructure spending. The Conference Board's manufacturing new orders data, while soft, could rebound if trade policies ease.
• Risk: Sensitive to economic slowdowns, but better positioned than tech for a “soft landing.”

3. Healthcare (XLV):

• Why: Healthcare's low beta (0.8) and 2.5% dividend yield make it a defensive play. The sector's focus on aging demographics and drug pipelines offers steady growth, uncorrelated to tech cycles.
• Risk: Regulatory and pricing pressures, but less exposed to AI-driven valuation bubbles.

Quantifying Mispricing: P/E Expansion vs. Earnings Growth

The data underscores why consensus-driven sectors like Tech are overvalued:

Metric	2023	2024	2025 (Est)
Russell 1000 Return	26.5%	24.5%	1.57% YTD
P/E Expansion Contribution	73%	51%	30%
Earnings Growth Contribution	21%	43%	45%

As earnings growth becomes the dominant driver in late-cycle phases, sectors with P/E ratios closer to earnings fundamentals (e.g., Utilities at 18x) outperform those relying on multiple expansion (Tech at 34x).

Investment Recommendations

1. Reduce Exposure to TMFC: Its tech-heavy focus and valuation risks make it vulnerable to a late-cycle correction. Consider trimming holdings or rebalancing to less concentrated ETFs like the Vanguard S&P 500 ETF (VOO), which diversifies growth and value stocks.
2. Shift to Underfollowed Sectors: Allocate to utilities (XLU), healthcare (XLV), or industrials (XLI). These sectors offer lower P/E ratios and defensive characteristics.
3. Monitor Fed Policy and Tariffs: The Fed's path of rate cuts (projected to 3.0% by 2027) could temporarily support valuations, but tariff-driven inflation risks remain. Stay agile.

Conclusion

The late-cycle phase demands a shift from consensus bets to contrarian strategies. TMFC's reliance on overvalued tech stocks and narrow leadership makes it a high-risk choice as growth slows. Instead, investors should prioritize sectors with structural tailwinds and reasonable valuations. By avoiding the herd and focusing on fundamentals, contrarians can navigate late-cycle volatility—and position themselves to profit when the cycle turns.

The market's reliance on P/E expansion alone is a late-cycle warning sign. Heed it.