Over the last few years a handful of technology stocks have dominated financial headlines. These global businesses, often called the "Magnificent Seven", have also driven the vast share of stock market gains. That said, these returns haven’t been generated in a straight line, with periods of strong positive momentum followed by sell-offs, representing typical market peaks and troughs.
Over July, we experienced one such ‘dip’, as investors began taking profits and moving investment stakes out of these tech giants and into other areas of the market - a process known as a market rotation.
Essentially, this refers to the systematic flow of money from one stock market sector to another, helping to explain why your portfolio might fluctuate even when the financial backdrop and economy are stable. Typically, when a small group of stocks performs exceptionally well for too long, there are concerns that their share prices have become disconnected from their actual corporate earnings. Instead of panicking and selling all their stocks in preference for cash positions, many investors simply "rotate" their profits into undervalued, overlooked or steadier industries. These rotations are often seen as a normal part of a healthy, long-term market cycle, as they prevent the stock market from becoming too top-heavy and allows the broader economy to share in the stock market's growth – a cooling system if you like.
The tech drawdown
July provided a perfect real-world example of how a market rotation unfolds and impacts investors’ portfolios.
During this market reshuffle, mega-cap technology and AI-related stocks faced pressure as investors questioned whether their high valuations were justified, given the significant levels of spending required to support future growth. This prompted a healthy market reset.
Over the month, leading semiconductor and microchip companies experienced a sharp pullback – in some cases of up to 20-30% – catching many investors off guard. However, instead of triggering a broader market crash, capital rapidly migrated into traditional “old economy” sectors. Investment capital did not leave the stock market entirely; it simply redistributed risk across hundreds of other underperforming companies left behind during the previous tech boom.
Consequently, small-cap stock indices representing smaller, domestic businesses dramatically outperformed the larger S&P 500. Through this rapid capital migration, traditional sectors like financials, industrials, real estate and energy suddenly emerged as the new leaders in equity markets, proving that the entire market shakeup was ultimately an incredibly constructive, necessary rebalancing of risk across the broader global economic landscape.
Historical examples
Whilst this most recent rotation felt sudden, it closely mirrored several prominent historical market pivots. More significant shifts include the post-election reflation trade in 2016, when a political shift sparked by Trump’s election fuelled expectations of corporate tax cuts and domestic manufacturing growth. In quick succession, investors quickly sold defensive mega-caps stocks in favour of cyclical banking, heavy machinery and domestic small-cap stocks.
Similarly, in 2020 during Covid-19, successful vaccine announcements fundamentally brightened the global economic outlook. The early winners across remote work technology, e-commerce companies and vaccine developers lost their momentum with capital instead being directed towards hospitality, airline and energy equities as the world reopened.
Navigating future market cycles
Market rotations are a natural and recurring feature of investing. As leadership shifts between sectors throughout the economic cycle, maintaining a well-diversified portfolio can help protect your wealth from periods of volatility while positioning you to benefit from future growth opportunities. This covers ensuring sufficient exposure to different market sectors, geographical regions and even extends to differing market caps, value versus growth stocks and dividend and non-dividend paying equities.
Over the last couple of years, we have continued to increase diversification across discretionary portfolios and adapt holdings in light of the new market regime characterised by higher interest rates, more persistent inflation and changing market dynamics. These changes have been focused on aligning the portfolios with the opportunities we believe will define the years ahead.
For example, we have brought in dedicated regional positions to help increase diversification, built out a skeleton of passive funds to help capture passive flows better and we have increased the allocation to true diversifiers to help our clients’ portfolios better navigate a world where bonds and equities have been increasingly correlated.
