The stock market’s August pullback may have been an opportunity to pick up some big tech names at newly cheap prices, but strategists say the broader market rotation away from the mega-cap names that until recently had led the rally will likely continue.
Philip Straehl, chief investment officer, Americas, for Morningstar Wealth, says he’s still positioned for this rotation. He remains underweight in big tech, which again looks expensive, and overweight in defensive and small-cap stocks, which have lagged behind the rest of the market. “We haven’t totally changed the profile of our portfolio on the back of what’s happened,” he explains.
Here’s what investors need to know about navigating a market in which the AI-driven rally in the largest tech names may not last.
Position for a Market Broadening
For the better part of a year, strategists have warned about the dangers of the stock market being overly concentrated in a handful of big tech names. They say the largest stocks could drag the market down just as easily as they’ve pulled it higher, and investors got a taste of that earlier this month when those stocks plunged.
Markets have since recovered, but Straehl says he remains positioned for broadening gains beyond the tech giants. He points specifically to defensive plays like consumer staples and REITs. “We had started to build more defensive ballast in our portfolio,” he says. Even before the rotation began, consumer staple stocks looked attractive. “It’s an area of the market where goods inflation had an impact … and we felt that with inflation coming down, margins ultimately would normalize.”
He was also overweight in small-cap stocks, which looked more attractive as mega-cap tech stocks gained market share. That proved prescient when the category popped at the beginning of the market rotation in July after lagging larger counterparts for months.
Take Advantage of Market Pullbacks
While the fundamentals of his portfolio position haven’t changed much after August’s selloff, Straehl says it was worth taking advantage of the volatility to rebalance and scoop up certain quality stocks at low prices. “There were periods when tech stocks and Japanese stocks were down pretty significantly, so that’s when we opportunistically pushed in,” he says. However, he emphasizes that most of this rebalancing happened on the margins of the portfolio: “Broadly speaking, we’re not that differently positioned from where we were mid-year.”
International Equities Look Like Opportunities
With the US market trading at a 2.8% premium to Morningstar analysts’ estimates of its fair value, Straehl is also looking abroad for bargains. “We do find opportunities in some niche areas outside the United States,” he says. These include some emerging markets and especially Chinese technology stocks. He explains that those stocks held up better than other markets during the recent volatility. He also points to positions in the United Kingdom and quality European stocks.
What About Big Tech?
With his portfolio positioned for a broadening market, Straehl says he’s underweight in the mega-cap tech stocks that have propelled stocks higher for the better part of the last year. “They’re not behaving defensively,” he says. “They sold off during the July rotation. They sold off heavily during the growth scare, and it’s not clear whether that was fully driven by fundamentals.”
As the “Magnificent Seven” stocks soared, they got more expensive. After seeing one earnings beat after another, investors now expect perfection. “If valuations are high, the bar is higher, and there’s more risk for disappointment,” Straehl says. “That’s an area where we continue to be underweight, even though in some cases we’ve opportunistically bought when prices move significantly.”
Straehl still likes the communication services sector, and he specifically points to Microsoft MSFT within the information technology sector. But other tech stocks “still look pretty expensive to us,” he says.
Bottom Line for Investors
Straehl cautions that there may be more volatility in store for investors over the next few months. “We’re at the beginning of a rate-cutting cycle,” he says, “and the Fed is really data dependent.” The November election in the US could also disrupt markets.
Against that backdrop, he says investors should be careful not to panic and sell when markets are choppy. Instead, it’s important to stick to a disciplined investment process and embrace opportunities as they come along.
“Keep your eye on the long term and don’t overreact to short-term news,” Straehl says. “If anything, use it as an opportunity to buy assets that might have fallen more than what the fundamentals justify.”
