Change of favorites on the markets: Tech stocks out – utilities, financial stocks and consumer goods in!

Frankfurt Stock Exchange: Actually, nothing fundamental has changed during the summer months: Nvidia and Co. are producing fat profits and the AI revolution remains the big topic on the markets.

However, there is something simmering beneath the surface:
Since the end of June, a change in favorites has been looming – tech stocks are being sold off, while traditional sectors are making a comeback.

Ali Masarwah, fund analyst and managing director of the financial services provider envestor, explains what investors should know.

When investors review what has happened after an extended summer break, they will not notice any major fundamental changes since the end of June. The data house Factset has published a review of the reporting of US companies in the second quarter.

According to the report, profit growth of companies in the S&P 500 between April and June was 10.8 percent.

This was the highest increase since the fourth quarter of 2021.

Sales growth for US companies was also satisfactory, with an increase of 5.2 percent in the second quarter.

And what do the markets make of it?

At the beginning of August, stock prices collapsed worldwide, a phenomenon that was repeated a month later – albeit with less force.

However, this statement must be qualified.

It is not THE share prices that have lost ground, but above all a market segment: tech stocks, more precisely: Nvidia and hyperscalers like Alphabet, Amazon, Meta and Microsoft, the main drivers of the AI hype.

In the four trading days following the announcement of brilliant quarterly figures, Nvidia lost $500 billion in market value on the stock market.

Other tech giants are also falling, although not as much as Nvidia.

The Financial Times has calculated that Nvidia, Apple, Microsoft, Alphabet and Meta have lost $1.8 billion in market value so far in the third quarter.

Industry rotation – now in this cinema

The memorable thing about regime changes is that you only realize they have happened after the fact. When they are underway, most investors remain in the “old days”. This is not surprising, because as a rule, trend changes do not occur in a straight line.

Only when a trend has become established do we accept that the situation has fundamentally changed.

Until the regime change is complete, most continue to draw lines of continuity based on fundamental data.

A good indicator of change is the stock market.

The stock market is a classic leading indicator of fundamental changes.

We anticipate the future, today is yesterday's performance.

Against this background, sector indices provide a good indication of expectations.

In both Europe and the US, interesting changes have occurred at the industry level over the past two months, as the table below shows.

12-month P/E ratio as of the end of August, returns in percent and in euros, 5-year performance annualized, the greener the return figures, the better in comparison to the industry, the redder, the worse, Europe is represented by ETFs on MSCI sectors, USA by ETFs on S&P sectors, data as of September 5, 2024, source: Morningstar.

The upper table shows, from left to right, the valuations (12-month price-earnings ratios). The columns further to the right show the returns of the stocks represented in the major sector indices.

In the US, tech stocks have been the big winners over the past five years, as shown by the annual increase of 21.5 percent.

Energy stocks – after a long drought – are expecting a rapid recovery in 2021 and 2022 as inflation rises.

The picture was similar in Europe, although tech stocks were nowhere near as successful as in the US. Between 2019 and today, in addition to tech stocks, the winners in Europe were industrial and financial stocks.

The healthcare sector also performed well. Long-term stocks from the consumer staples and utilities sectors have performed poorly in the US since 2019. In Europe, the losers were also consumer staples, telecoms and luxury goods.

Since June, this picture has changed completely. In the USA, utilities stood out with an increase of a good 8.5 percent between the beginning of July and the beginning of September.

Financial stocks and consumer staples stocks were also well acquired. Healthcare stocks were also comfortably in positive territory over the past two months.

In contrast, US tech stocks have fallen by a good 10 percent since the beginning of the third quarter.

Energy stocks and telecoms also performed poorly. With regard to the latter, it should be noted that tech platforms such as Meta and Alphabet have been classified as telecommunications service providers since 2019.

In Europe, the winners of the third quarter so far have also been utilities. They have risen by a good 11 percent since the beginning of July. Telecoms and consumer staples stocks are also among the winners.

So yesterday’s losers are today’s winners.

European tech stocks, on the other hand, have fallen by a good 13.5 percent since July. Energy and luxury consumption are also among the losers this quarter.

Conclusion: Is it different this time?

The sector rotation seems to be getting underway.

While tech stocks have been losing ground since the beginning of July, classic, boring sectors such as utilities, financial stocks and consumer goods are becoming popular again among investors.

The thesis of a change in favorites is supported by the outperformance of small cap stocks, which we have also been observing since the beginning of July.

In the US, for example, since July the small-cap index Russell 2000 has outperformed the equally weighted S&P 500, which in turn outperformed the (capitalization weighted) S&P 500.

False signals cannot be ruled out in these timely observations, but it seems likely that things will be different this time and that we are facing a renaissance of the traditional sectors in the wake of the announced interest rate turnaround.

This does not necessarily mean a crash of tech stocks, and an end to the AI hype is also not likely.

But tech stocks could be in for significant underperformance in the coming months.

Investors should take this scenario as an opportunity to ensure that their portfolios are well-diversified.