Wells Fargo: Take profit in IT stocks, go to industrials, utilities, financials

Wells Fargo Investment Institute has downgraded the S&P 500 IT sector – home to Nvidia, Microsoft, Broadcom, and other major beneficiaries of the AI boom – from “favorable” to “neutral,” citing stretched valuations, MarketWatch reports. WFII also highlighted several other sectors they believe are more attractive for investors at this stage of the cycle.

Wells Fargo Investment Institute (WFII) downgraded its recommendation on the technology sector in the S&P 500 to "neutral," MarketWatch reported . The bank had maintained its advice to buy IT stocks since April 4 - after the announcement of higher trade duties caused the market to crash. Since then and through Oct. 24, the sector has gained 60%, outperforming the S&P 500 index by more than 25%, said WFII global investment strategist Douglas Beath. But now WFII believes the sector is overvalued and it's time to take profit, MarketWatch notes.

Beath acknowledged that the AI boom is likely to continue supporting revenue and earnings growth across the sector. He also noted that tech companies generally carry low debt levels and generate strong free cash flow. In addition, AI-related capex continues to accelerate, and recent quarterly earnings from major tech companies exceeded already-elevated expectations.

At the same time, Wells Fargo flagged growing risks. “However, valuations have surged, and we are wary that overly bullish sentiment toward the group and elevated expectations make the sector susceptible to disappointment in the near term,” Beath said.

Wells Fargo also pointed to several additional threats for large-cap tech stocks. Technology transfer remains a central issue in U.S.-China trade negotiations, and tensions between the two countries have not fully dissipated. Meanwhile, the rapid expansion of AI-related capex has begun to unnerve investors, given concerns about future payoffs and debt financing, in line with the lessons from the dot-com bubble.

“The pullback ultimately may prove to be short-lived, but we think the sector remains vulnerable to negative surprises, potentially including even modest misses in corporate earnings reports. We favor locking in gains by trimming IT exposure back to the sector’s market weight,” Beath said. 

WFII recommends reallocating capital toward three sectors it continues to rate as favorable: industrials, utilities, and financials.

“The industrials and utilities sectors can allow investors to participate in AI through the booming ancillary data-center trend, but with lower valuations than IT,” the WFII strategist said. “We believe financials can benefit from a steepening yield curve and a more favorable regulatory environment – and also supports AI through merger & acquisition activity and debt financing – while trading at a significant discount to the S&P 500.”

Capital spending by the largest tech companies continues to surge. Microsoft’s capex in the current fiscal year is expected to exceed $94 billion, Meta’s to surpass $70 billion, and Alphabet’s to top $91 billion. However, investors are increasingly concerned about future payoffs and debt financing, which has fueled volatility, CNBC reported.

Against that backdrop, shares of AI companies sold off sharply last week. Nvidia fell about 7%, while Palantir dropped by more than 11%. The declines dragged the Nasdaq Composite Technology Index down 3% between November 3 and November 7, marking its weakest weekly performance since April.

On Tuesday, November 11, Japanese conglomerate SoftBank unexpectedly disclosed that it had sold its entire stake in Nvidia for more than $5 billion. Nvidia shares were down as much as 3.9% during Tuesday’s session following the disclosure.