With stocks priced to perfection, senior portfolio manager outlines key risks and areas for possible diversification
From getting crushed by interest rates to a wild AI-driven advance in 2023, the tech sector has gone through exciting times in the past couple of years. After the most recent movement, tech stocks are priced for perfection … which is causing some concern for one top portfolio manager.
“There’s huge crowding into that segment,” says Martin Pelletier, senior portfolio manager at Wellington-Altus Private Counsel. “That’s not unusual: investors like to feel confident about what they’re buying, and there’s no better tailwind for confidence than when markets have had a good run.”
Citing the CFTC, Pelletier says the tech-heavy NASDAQ has hit the highest levels of speculative long positions since data on that started getting recorded. He adds that levels of US equity futures among asset managers – which are tilted toward mega-cap tech stocks – are also at their highest and most extreme since 2014.
“A lot of momentum has been established,” he says. “We saw a little bit of a selloff to begin this year, and then a recovery; 42% of that move back was in 10 companies, with two companies alone – Apple and Nvidia – accounting for 20% of the rally.
“I think there’s a lot of optimism and perfection priced into the stocks, and there’s a number of things that can go wrong to derail that,” Pelletier says.
Because technology stocks are long-duration, he says they’re highly sensitive to interest rates. While he says numerous analyses of the S&P 500 are factoring in six to seven rate cuts this year, that hinges on inflation coming back down to levels much closer to the 2% target central bank policymakers aim for.
“We’re directionally headed that way. But inflation levels bottomed in June last year, and haven’t really gone anywhere since then,” he says. “It’s going to be tough to see further decreases in inflation, so there’s a probability that we don’t get those six to seven rate cuts.”
Aside from interest rates, Pelletier sees uncertainty on the geopolitical front. Taiwan’s upcoming election, he says, faces a risk from China’s military manoeuvrings over the past few months. Should that devolve into a full-fledged military incursion, he says it would have a material impact on the semiconductor space and high-flyers like Nvidia.
“It’s a low probability, but it’s still a probability,” he says. “When things are priced to perfection and sitting at all-time highs, all it takes is something to come in from left field to derail that.”
For investors who have done well last year, including some who managed to break even since the carnage of 2022, Pelletier suggests it’s a good time to look at diversifying into areas of the market that weren’t able to participate significantly in the upside market moves of 2023.
Some corners of the market, he underscores, haven’t reaped the full benefits of movements in interest rates; that includes the utility sector, which he’s currently taking an overweight position on. A flareup in geopolitical tensions in the Middle East, he adds, could catalyze a large upside move among oil stocks.
“We’re also using structured notes to de-risk portfolios,” Pelletier says. “We recently sold off our Russell 2000 [holdings] on some respectable gains, reduced our S&P 500 exposure on some very nice gains, and did a structured note on the Russell 2000, that'll pay us a 10.3% coupon with 30% downside protection.”
Looking beyond stocks, he sees long duration bonds as an area worth paying attention to. Bond investors have not been as aggressive in their rate-cut expectations as equity investors, he says, which means they could be ideal for investors with a more conservative bent.
“There's a safer trade if you are going to play rate cuts in the bond market than some of these tech stocks,” he says.
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