Capital Rotation: Where Investors Are Focusing Their Attention

This week’s sell-off has led to a broader capital rotation out of the Technology sector and into the Energy, Consumer Staples, and Healthcare sectors. The first is driven by natural gas, while the second and third reflect a defensive approach by investors. Sectors like Consumer Staples and Healthcare typically perform better in risk-off environments.

The healthcare sector has also benefited from recent strong earnings results, announced acquisitions, and a reduction in political uncertainty surrounding drug pricing. For example, deals were made with Eli Lilly (LLY) allowing them to sell obesity drugs to Medicare/Medicaid patients. This represents a huge market potential for LLY while maintaining profitability.

What has been performing disastrously are stocks in the Consumer Discretionary sector, such as restaurants, hotels, airlines, and retail. Many of these companies reported weak third-quarter results as consumers cut back on spending. Low-income consumers are shifting to more affordable options and reducing discretionary spending. The gap between the wealthy and low-income consumers is widening to unsustainable levels.

Meanwhile, unprofitable tech stocks continued to sell off. This included “hot” thematic stocks such as robotics, space exploration, quantum technologies, drones, batteries, and nuclear energy. This typically happens when liquidity (money supply) is removed from the financial system.

Specifically, companies that manufacture memory chips and storage systems finally collapsed after a torrid multi-month rally. For example, Sandisk (SNDK) had risen 10 times from its April lows! When tech stocks rise parabolically like this, the downside is often equally dramatic, especially if triggered by a negative catalyst.

The good news is that the rotation may be coming to an end. Many of these “junk” tech stocks have fallen 40%-50% from their recent highs. For example, Rigetti Computing (RGTI), a popular quantum company, is down -59%. Oklo (OKLO), a nuclear reactor developer, has dropped -52% from its October highs.

Although the major indices began pulling back about 12 days ago, individual tech stocks had been correcting for several weeks. So by the time we saw large declines in SPX and QQQ, the wipeout was nearly over, and the heavily beaten-down stocks were starting to show significant reversals.

Throughout this period, the Mag 7 fell less than the unprofitable tech stocks. This aligns with the “flight to safety” dynamic, where investors seek high-quality, defensive companies. However, a selloff in junk tech is not a cause for a sustained broad market correction. We could see the rally resume if there is a broadening into cyclical sectors such as Industrials, Financials, Consumer Discretionary, and small-cap stocks.