After rallying for most of the year and carrying the major indices to new highs, tech stocks (XLK) have been mostly pulling back during the past couple of weeks. In fact, the tech sector has pulled back almost 5% during the past month. Although it’s too early to say if this will turn into a meaningful rotation out of tech and into undervalued industries, it’s worth keeping track of where the money is flowing. These are the top three sectors benefitting from tech’s decline based on their performance during the past month:
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All these sectors have one specific thing in common – they’re sensitive to interest rate changes.
How Interest Rates Are Impacting XLRE, XLF, and XLU
Real estate companies have a tougher time selling houses when mortgage rates climb, as it increases the consumer’s borrowing costs while also making it difficult to qualify for a loan. This often forces homebuilders to offer discounts and incentives in order to attract new buyers, which pressures margins.
On the other hand, financial companies can lend out money at higher interest rates, potentially boosting net interest margins. Still, higher rates mean fewer loan approvals and the potential for more debt defaults, therefore canceling out some of the added benefits of higher rates. In addition, financial companies tend to invest in stocks, bonds, and real estate, which (if not a tech/chip stock with AI aspirations) generally struggle during rising interest rate environments, thus potentially impacting investment profits.
Finally, we have utility stocks, and they are impacted in a completely different way. Since these companies tend to produce stable cash flows, pay generous dividends, and grow slowly, regardless of the economic conditions, they tend to have bond-like performances. Indeed, higher interest rates make their dividend payments less attractive, as they’re seen as not worth the extra risk when compared to money markets that are considered risk-free.
Cleary, investors within these sectors prefer lower rates, and that’s what they’re beginning to price in. With Federal Reserve officials speaking in a way that implies rate cuts could be coming soon, traders seem to be flocking into these sectors in anticipation.
Which Sector Has the Most Upside?
While investors seem to be rotating out of tech stocks, Wall Street analysts still expect those very same stocks to rally the most. In fact, they have a consensus price target of $265.95 per share of XLK, which implies over 24% upside potential. Nevertheless, if you are a shorter-term trader looking to capitalize on current market momentum, then XLRE might be worth a look, as it has been the laggard on a year-to-date basis but is seeing the strongest surge during the past month.
