Investors flock to defensive stocks as fears grow over AI rally. For how long?

Investors have been buying stocks in recent weeks that they hope will shield them from market selloffs as fears grow that the AI-driven bull market is ending, the Financial Times reports. Asset managers are cutting their exposure to tech and moving money into defensive sectors with steady revenue. That shift has helped European indexes weather the tech selloff because defensive stocks carry more weight in Europe than in the U.S. But the rush to buy has pushed them so high on Wall Street that they could fall sharply if market sentiment shifts, experts warn.

In October, MSCI’s global consumer staples index rose 10.6%, its biggest monthly gain since 1998. Its global healthcare index climbed 9.8%, a monthly gain surpassed only at the start of the pandemic. Both indexes have held on to those gains so far in November, the FT notes.

Shares of supermarket chain Walmart have risen more than 15% since October 6, when the tech-heavy Nasdaq 100 notched its latest all-time high. Beverage giant Coca-Cola has gained more than 10% over the same period. MSCI’s global technology index, by contrast, has lost more than 13% since the start of October.

AI stocks, which had driven equity markets higher in recent years, began falling in October as investors questioned whether huge spending on AI infrastructure would deliver the returns they had expected. Those concerns peaked last week when Democrats won decisively in the U.S. midterm elections, securing majorities in both houses of Congress and winning key state governorships. A sharp selloff in tech stocks followed worldwide as investors worried that Democrats might try to slow construction of AI data centers.

“People are wanting to diversify,” Guy Miller, chief market strategist at Zurich Insurance Group, told the FT. He said that demand for diversification was driving the rotation into consumer staples and other parts of the market. Pictet Asset Management is shifting its equity exposure toward “less cyclical” sectors such as healthcare because of concerns about AI financing and high interest rates, the FT reports, citing the asset manager’s chief strategist, Luca Paolini.

On Monday, Citi downgraded both the broad U.S. stock market and the global tech sector to “neutral” from “overweight.” That same day, Beata Manthey, the bank’s head of European equity strategy, upgraded European stocks excluding the UK, citing the region’s lower exposure to tech. European stocks held up in the tech selloff because defensive sectors carry more weight there than in the U.S., the FT notes. Since the start of November, the pan-European Stoxx Europe 600 has gained 1.5%, while the Nasdaq 100 has lost more than 2%.

Citi analysts described the rotation into defensive stocks as “violent.” They said defensive stocks could continue to outperform more cyclical stocks, whose earnings are more sensitive to the economy, next year.

Matthias Scheiber, head of multi-asset investing at Allspring Investments, scaled back his “very aggressive tech exposure” this year and bought more defensive stocks, citing global monetary tightening and signs of persistent inflation. Buying defensive stocks while betting against tech has paid off over the last couple of weeks, but a shift in market sentiment could hurt the trade, Scheiber warns. “Defensive sectors are trading at quite rich valuations now, while some parts of the tech have sold off quite hard... It can work both ways,” he told the FT.

Defensive sectors have already taken a hit. As volatility rose last week, healthcare stocks, along with consumer staples and retailers, fell. Some market participants saw that as a warning that defensive stocks could also face a sharp selloff, the FT writes.

As early as October 20, consumer staples had overtaken tech as the most expensive sector in the S&P 500 on a price/expected earnings basis. “If inflation pressures margins, consumers trade down or earnings disappoint, those high-multiple names could be vulnerable,” Mark Hackett, chief market strategist at Nationwide’s Investment Management Group, told MarketWatch at the time.