Reuters: Cheaper, smaller stocks benefitting from risk aversion in tech sector

After the "SaaSpocalypse," investors are reducing positions in the overheated U.S. tech sector and speculative assets in general in favor of undervalued stocks. These capital flows into the broader market are supporting small caps, dividend-growth names, and equal-weight indexes, Reuters reports.

Investors are rotating into cheaper small-cap stocks after a spike in volatility hit software companies and speculative assets, according to Reuters. Caution and risk-off sentiment have weighed on the leaders of last year’s rally – tech giants and beneficiaries of the AI boom – with capital shifting toward industrials, energy, and commodities.

Against this backdrop, on Friday, February 6, the Dow Jones Industrial Average hit a record high, while the market value of software companies fell $1 trillion last week. The smid-cap Russell 2000 index jumped 3.5% on Friday, outperforming the S&P 500 and the Nasdaq 100, Reuters noted.

Tim Murray, capital markets strategist at T. Rowe Price, said the selloff in megacap tech and software has come to a stop, replaced by aggressive buying of entirely different stocks. Investors are reassessing the risks of investing in AI hyperscalers – Amazon, Microsoft, and Alphabet – as well as the downside of companies whose business models AI might disrupt. “Now, they're all chasing to buy cheaper companies, perhaps indiscriminately,” Murray was quoted by Reuters as saying.

Simeon Hyman, global investment strategist at ProShares, said the shift of capital into the broader market is likely to prove durable after a prolonged period dominated by megacap tech. “Dividend growth, equal-weighted indexes, smaller companies are all likely to be beneficiaries,” he said.

As a result, the market is becoming increasingly divided between longtime darlings and a new crop of stocks that investors are eyeing for returns, said Citigroup U.S. equity strategist Scott Chronert. “While we've all been sitting here focused on this AI debate, the market already has been ⁠moving in a different direction as investors have decided they don't just want to buy more of what they already owned at an even higher price. Instead, quietly, we've seen money move into energy stocks, materials companies, ‌staples and industrials,” he said.

Last week, a team of BofA analysts led by Michael Hartnett named smid-cap stocks as the best bet ahead of the U.S. midterm elections in November. They recommend "buying Main Street, selling Wall Street" as Trump's “aggressive intervention” to reduce borrowing costs, energy prices, and health care, housing, and electricity bills is putting pressure on sectors such as energy, pharmaceuticals, banking, and Big Tech.