Any Pullback in Tech May Signal a Rotation into These 3 Sectors

Key Points

• Technology stocks, in general, and AI stocks, in particular, have been a good trade for investors in the last 18 months.
• However, investors who believe in diversification are waiting for the market to broaden out. 
• A look at some sectors with high institutional buying should point investors to these three sectors.  

The rise of artificial intelligence has been a gift for investors who own one or more of the technology stocks that stand to benefit from AI. Not only has this been a good trade, but many of these stocks, such as NVIDIA Corp. NASDAQ: NVDA and Microsoft Corp. NASDAQ: MSFT, are also great buy-and-hold stocks.  

The problem for investors who believe in diversification is that the most significant gains have been limited to a small group of stocks, including the Magnificent 7 stocks. As 2024 reminds investors, technology stocks are volatile at any time, but particularly when many are trading for premium valuations.  

But there is a sense that things are changing. It’s becoming more likely that the Federal Reserve will only lower interest rates once, if at all, in 2024. But the overwhelming sense is that the Fed’s next directional move will be to lower rates. That has investors looking for areas to deploy capital that’s either on the sidelines or currently invested in tech stocks.  

This shift may have major benefits for investors in the sectors that institutions are buying. Here are three sectors that look like suitable investments for the second half of 2024. 

Energy Stocks Will Heat Up 

Energy stocks are cyclical in nature, and that cycle has been bearish. That’s confounded some investors because the OPEC+ nations show no inclination to increase production. They want and need the price of oil to be much higher. 

But there are reasons to believe that there’s something else going on with oil prices outside of normal supply and demand dynamics. The Biden administration has repeatedly tapped the nation’s Strategic Petroleum Reserve (SPR) to ease prices at the pump.  

That move has worked, with the Federal Reserve keeping interest rates at a level that keeps demand in check. But any drop in interest rates will be bullish for oil prices. Investors should also be looking at companies that produce natural gas, which is likely to see high demand from data centers.  

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There’s further evidence that energy stocks are likely to move higher. That is, institutional ownership in the Energy Select Sector SPDR Fund NYSEARCA: XLE shows significant institutional buying in the last three quarters.  

Industrials Continue to Be an Infrastructure Play 

The Inflation Reduction Act was the government’s effort to jump-start the rebuilding of our national infrastructure, including roads, bridges, water treatment facilities, and updating our aging electrical grid.  

Investors may first notice this activity in the price of commodities such as steel, aluminum, and copper. And as these projects advance, it should be bullish for industrial stocks such as Caterpillar Inc. NYSE: CAT and Deere & Company NYSE: DE.  

Unlike the energy sector, some of the individual names in the industrial sector have been pulling back in recent months. However, the Industrial Select Sector SPDR Fund NYSEARCA: XLI shows buyers have outnumbered sellers for the last six quarters.  

Consumer Discretionary Stocks May Be a Holiday Gift 

The consumer discretionary sector will likely be among the biggest beneficiaries of lower interest rates. As the name of this sector highlights, these companies produce goods and services that are nice to have but not must-haves for consumers.  

Some consumer discretionary stocks held up well as inflation surged, as rising wages helped consumers keep up with the rising prices. Companies with pricing power, like PepsiCo Inc. NASDAQ: PEP, continued to post solid earnings. However, as the inflation rate remains above “normal” levels, these companies are facing more complex comparisons.  

However, once again, investors would do well to follow the money. In the case of the Consumer Discretionary Select Sector SPDR Fund NYSEARCA: XLY, buying activity is nearly triple that of selling activity in the last 12 months. And going back 18 months, you still see institutions gearing up for a sector rotation.