The technology-driven market has been extremely narrow, with the 10 largest stocks driving a disproportionate amount of the market’s gains so far this year. Even though the AI revolution will create some big winners—and some technology mega-caps offer strong growth potential—we think it is short-sighted for investors to pile too heavily into the technology sector because of a single theme.
Beyond technology, some sectors have performed as you might expect in a higher-rate environment, while others have not. Consumer-staples and utilities companies have underperformed, as expected. Yet more cyclically-sensitive sectors such as industrials and financials, which would typically be expected to do well in a higher-rate world, have underperformed. Healthcare stocks, which are often prized for their defensive characteristics, have also lagged.
Prepare for a Broader US Market
Some investors may feel flustered by these conditions. Portfolios that aren’t heavily weighted toward the 10 largest stocks that dominated in recent months have lagged the market. However, we believe that a broadening of market performance is possible in the coming months, and equity portfolios should position accordingly, looking toward parts of the market that have strong underappreciated return potential.
As the earnings revisions data above show, US companies across many sectors have experienced an earnings recession over the last year. But worst-case fears haven’t materialized. Earnings, like the US economy, have been largely more resilient than feared. If inflation continues to cool, and a big economic contraction is avoided, we believe these conditions should support stronger fundamental and stock price performance of a wider range of stocks beyond mega-cap technology.
Flexible Strategy for Near-Term Risks
In such fluid market conditions, we think a flexible equity strategy can be very rewarding. Healthy consumer spending should help ensure that an economic slowdown will be mild, in our view. If the economy holds firm, we believe the energy, financials and industrial sectors deserve closer attention. Since stocks in these cyclical sectors have faced downward pressure this year after outperforming in 2022, their valuations are relatively attractive. Within these sectors, investors can find reasonably priced shares of companies that offer solid earnings-growth prospects and capital-return potential.
Select technology companies do have a role to play in equity portfolios today, in our view. Even among the mega-caps, in some cases, valuations can be justified based on the durability of businesses, balance-sheet quality, margin resilience and long-term growth potential.
Identifying defensive sectors also requires flexibility in our view. At the moment, we believe quality stocks in utilities and consumer staples—traditional defensive sectors—are less appealing, given their stable but slower growth profiles, against a backdrop of higher interest rates and economic resilience. Should economic conditions deteriorate, we would expect defensive quality to come back into vogue. So, investors should be prepared to shift toward these areas if warranted.
Flexibility can be a virtue in equity investing. Today, with so many near-term risks looming—and the possibility of increased volatility, equity investors must stay on their toes, avoid being swayed by thematic exuberance and focus squarely on long-term company fundamentals. When markets appear to be complacent about macroeconomic concerns, striking the right balance between near-term risks and long-term opportunities is the key to positioning for a wider-than-usual range of expected market outcomes.
