Sector Rotation

 Investors are hearing a lot right now about how weak the overall market is. Pundits are saying that only a few stocks are carrying the indices higher and that if you look more broadly, stocks are in a bear market. But this simply is not the case. What’s actually going on is classic sector rotation. In the second half of last year (after a horrific first 6 months), all sectors other than tech started advancing. Oil and gas companies had banner years, banks did well, and so did consumer staples and industrials. As interest rates rose through 2022, companies that relied on lots of cash to fuel growth and operations suffered greatly. Then two powerful forces came together and changed their fate. Inflation began to ease (bringing interest rates with it) and the AI revolution kicked off. Growth stocks surged as money flowed back into the technology space and out of defensive, low volatility stocks. So when analysts look at the markets this year, they see a narrow area of performance and remain overly pessimistic. But this is not a market breadth thing, it’s just a rotation thing. Conversely, when tech underperforms, the broader market outperforms on a relative basis. However, this does not mean there is more market participation or that the markets or economy are healthier. When Apple and Google do well, of course the indices are going to be lifted even if other companies aren’t advancing as much. It’s just like in sports, your best players are supposed to score the most points and carry the team. And the best players in the economy right now are mega-cap growth companies.

Within the growth and technology space some trends are emerging. Semiconductors are leading with Nvidia becoming the first chipmaker to reach a trillion-dollar valuation. Apple is near its all-time high as it too makes chips and time spent on mobile devices per day has gone from 25 minutes in 2010 to over 4.5 hours today. Software stocks are also at 52-week highs (still down from their COVID peak) led by Microsoft, Salesforce, and Adobe. And any company that is AI adjacent is getting a huge pop.

There is a chance that AI will be as large a force and shape our lives as much as the internet did in the late 90s. If this is the case, then we are at the very early stages of this economic shift. The bulk of the market moves to come will likely feel like “irrational exuberance,” as Alan Greenspan put it during the dot com bubble. There will also be some quick and nasty pullbacks in AI and tech along the way. But pullbacks rarely come when people expect them. Look at Nvidia. It had nearly doubled year-to-date heading into earnings. Many trades opened short positions, betting against the stock thinking it was overvalued. Then the earnings were announced (which were stellar) and the stock jumped 30% - the largest post-earnings gap for a mega-cap stock ever, adding over $200 billion in market cap in a single day. The dips will come when everyone is on the AI and tech train and bought into the story. And the dip will be so brutal investors will question the narrative. This will be another good entry point for the sector.