Stock market rotation drives recovery after summer sell-off

Technology giants reminiscent of Nvidia Corp. and Microsoft Corp. have led gains within the stock index over the past two years as investors were drawn to their booming profits and exposure to artificial intelligence. But now traders are shifting to sectors reminiscent of real estate, utilities and consumer goods as they fear faltering economic growth and the Federal Reserve prepares to Start by lowering rates of interest already on Wednesday.

Since the S&P 500 peaked on July 16, the so-called “Magnificent Seven” technology stocks — Nvidia, Microsoft, Apple Inc., Alphabet Inc., Amazon.com Inc., Meta Platforms Inc. and Tesla Inc. — have mostly slumped, with the Bloomberg Magnificent 7 Index down 5.3 percent. And while the broader stock index has lost lower than 1 percent in that point, largely on account of the S&P’s outsized weighting of those fast-growing tech giants, normally sleepy sectors have led the index by a large margin, with each real estate and utilities gaining 11 percent.

These numbers include last week’s rise within the S&P 500, led by the technology sector.

“Investors like to look at companies whose earnings are declining and are now rising,” said Michael Casper, equity strategist at Bloomberg Intelligence, in an interview. “That leads them away from the technology sector and toward the other 493 stocks they’ve pushed aside.”

Recession test

The rotation was fuelled by expectations of monetary easing, but additionally it is evidence of improving earnings prospects in the remainder of the market at a time when high spending by tech giants is raising concerns about their margins.

Whether it is a blip or a longer-term trend, nevertheless, will likely depend upon how the economy performs. Markets will get a transparent indication of that from the Fed this week, with traders roughly split on whether the central bank will deliver a quarter-percentage point or half-percentage point cut.

“We don’t think we’re going into a recession, and the stocks that are going to lead are the cyclical stocks that will benefit from higher economic growth and lower interest rates,” said Adam Grossman, chief investment strategist for global equities at Riverfront Investment Group, adding that large-cap technology stocks remained his firm’s largest obese.

A deterioration within the economy would likely profit defensive sectors, but in response to Keith Lerner, co-chief investment officer at Truist Advisory Services, this also tends to be an excellent environment for technology stocks.

“If there is some uncertainty, we think investors will continue to pay a premium for growth prospects,” Lerner said in an interview. “If things continue to slow, defensive assets will continue to do well. In either case, whether there is a downturn or some stability, I think technology is doing well.”

Another factor helping industries outside of technology is the improving earnings outlook. Take the healthcare sector, for instance: After seven consecutive quarters of declining profits, profits for healthcare firms rose 16% within the second quarter, in response to data compiled by Bloomberg Intelligence. That rise is anticipated to proceed for the remainder of the yr, with earnings growth expected to achieve 45% in the primary quarter of 2025.

Technology slows down

Of course, the tech giants’ profits remain strong. They are only not rising as fast as lately, after they were driven by regular revenue growth and a concentrate on efficiency that resulted This resulted in lots of of 1000’s of job losses across the industry.

The Magnificent Seven reported a 36 percent increase in profits within the second quarter. While impressive, that is lower than the three quarters before that, when profit growth fell by greater than 50 percent. And over the following 4 quarters, profits are expected to rise by 17 to twenty percent, in response to BI data.

Part of the sell-off in stocks of major technology firms last month was on account of firms spending heavily on equipment used for AI computing. Last quarter, Amazon, Google parent Alphabet, Microsoft and Meta Platforms combined to take a position greater than $50 billion.

One big beneficiary of the money is Nvidia, whose semiconductors are prized for the computing power needed to run AI models. But more broadly, it has also raised concerns amongst investors concerning the profit margins of the chipmaker’s biggest customers – especially since there’s little sign thus far that the spending is translating into the revenue growth needed to financially justify the expenditure.

While the downturn has lowered valuation multiples for a lot of technology stocks, they’re still high. Microsoft, for instance, is valued at 32 times forward earnings for the following 12 months. That’s down from a peak of 35 in July, but still well above the typical of 25 over the past decade.

Cheaper valuations in other areas of the market will likely proceed to draw investors. But that does not imply the technology sector won’t proceed to perform well, although the boom in AI-related stocks like Nvidia is drawing comparisons to the dot-com bubble, says Michael Mullaney, head of worldwide research at Boston Partners.

“The other 493 are much cheaper and will probably get a little more, but that doesn’t mean throwing the baby out with the bathwater,” he said. “These companies are printing money like crazy. That’s a big difference from 2000.”