There are 4 reasons tech's dominance over the stock market could end this year
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- Technology stocks have dominated the market for more than a decade.
- However, strong outperformance in tech may begin to spread to other sectors of the stock market, according to BofA.
- Here are four reasons tech stocks' dominance could end later this year, according to the bank.
The technology sector's dominance over the stock market could finally end later this year, according to Bank of America.
Driven by significant earnings growth, tech-leaning growth stocks have largely been favored over value stocks by investors for years, even when accounting for a painful hiccup during the 2022 bear market.
Bank of America equity strategist Savita Subramanian argued in a Monday note that returns in the stock market could start to broaden out and favor other sectors by the fourth quarter of this year.
"If rates remain high (and we see multiple reasons for higher for longer rates and inflation as we highlight below) we would expect to see a broadening of the S&P 500 with better returns from shorter equity duration vehicles (higher near term cash flows) than from pure, buy-the-dream long duration growth stocks," Subramanian said.
These are the four reasons Subramanian sees tech's dominance waning.
1. It's earnings, not the economy
While low interest rates, excess liquidity, and weak economic growth have been commonly cited as the direct drivers of tech stocks since 2009, it really comes down to earnings.
"Tech out-earned, thus Tech outperformed," Subramanian said.
But earnings growth differentials between tech and non-tech companies are finally beginning to narrow, and that should gain the attention of investors.
"As earnings accelerate outside of Tech, investors will likely become more price sensitive and seek out cheaper earnings growth," Subramanian said.
2. Higher for longer interest rates
"Clearly earnings are the critical driver of outperformance, but higher rates could disproportionately hurt credit sensitive, long duration growth stocks that still trade at lofty premia to higher cash return, shorter duration counterparts," Subramanian explained.
Subramanian said interest rates could continue to move higher, or at least stay higher for longer than most expect, because of waning demand for US 10-year Treasuries from the Federal Reserve and foreign buyers like China and Japan.
Meanwhile, higher nominal GDP growth puts upside pressure on real interest rates, and US sovereign risk evidenced by record levels of debt to GDP suggests a higher required return from Treasury bonds.
3. Current economic cycle favors cyclical leadership
According to Bank of America's proprietary models, both the US and European economies are showing signs of entering the phase 1 "recovery" regime, which has historically favored value stocks over growth stocks.
"Information Technology and Communication Services have lagged in past Recovery regimes" with a 44% hit rate, Subramanian said.
4. Long-term AI beneficiaries might be outside of tech
While technology stocks have been at the heart of the artificial intelligence-induced stock market rally, that could change as the adoption of AI hits saturated levels.
Shares of Nvidia and hyperscalers Microsoft, Amazon, Alphabet, and Meta Platforms have surged as they invest heavily in AI-enabled GPU chips. But those gains could be temporary and the lasting gains could be companies outside of the tech sector that see long-term margin improvements from integrating AI into their business.
"Capex takers within Tech could be transient beneficiaries," Subramanian said, adding that a similar dynamic played out with Rockwell Automation during the COVID-19 pandemic.
"COVID started a 3y ramp in automation spend after which ROK became a core holding of active long only funds, hitting a 20% overweight. ROK is now 60% underweight in the average fund, but capex spenders that grew labor-light have re-rated. Service sectors may be next in the AI disruption train," Subramanian said.
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