Tech Stocks Have Had It Tough. Why Investors Shouldn’t Get Too Defensive Just Yet.

Nvidia reports quarterly earnings on Wednesday evening. (Dhiraj Singh/Bloomberg)

Key Points

• The healthcare sector has outperformed the Magnificent Seven, and the Dow Jones Industrial Average has surpassed the Nasdaq Composite since late October.
• Depreciation tax provisions in the One Big Beautiful Bill Act are expected to improve cash flow, supporting profitability and stock prices.
• Momentum is showing the strongest 65-day returns among all factors, with its absolute price trend beginning to break out.

Stocks are heading higher Wednesday in hopes that Nvidia earnings can reinvigorate artificial-intelligence stocks. Yet even if that doesn’t happen, there are still reasons to consider buying the dip, or at least not fleeing for safe harbors.

Recent fears about the AI trade fizzling had led investors to rotate out of recent winners and into some more defensive sectors — though not all.

In fact, as PGM Global strategists note, the healthcare sector has outperformed the Magnificent Seven, while the Dow Jones Industrial Average has done better than the Nasdaq Composite since the end of October.

Nonetheless, they warn that these “rotations can work for brief periods, but unless there is a structural shift in the economy, the microstructure of the equity market almost ensures such rotations will be short-lived.”

It’s true that big tech companies are spending an eye-watering amount on AI development, raising concerns and comparisons to the dot-com bubble, when capital expenditures led to deteriorating free cash flow. However, PGM notes that depreciation tax provisions in the One Big Beautiful Bill Act should allow cash flow to improve, supporting profitability and stock prices.

“In sum, we think that if investors remain holed up in defensive sectors, they risk underperforming the market (and peers) as AI demand continues and passive flows remain relentless,” the firm says.

Likewise, Renaissance Macro Research’s Jeff deGraaf notes that even if investors do think we’re in a tech bubble redux, it’s still not time to flee toward truly defensive parts of the market. Looking at the pop 25 years ago as a guide, after high beta stocks (i.e. those with greater volatility than the broader index) rolled over, momentum stocks took over with leadership positions, before later peaking around the same time as the broader market.

In fact, that might be playing out now, going by technical trends.

“Currently, momentum is showing the strongest 65-day returns of all factors, its absolute price trend is beginning to break out, and its performance is not stretched,” deGraaf writes, highlighting the Russell 1000 Momentum index. “From here, we believe momentum is positioned to remain leadership, and we would look to increase exposure.”

If the tech bubble pattern holds, it won’t be after the momentum trade peaks that value takes over.

“Bubbles don’t tend to pop when rates are going lower…we likely have more time,” deGraaf adds.

PGM also points out that passive index investing—bolstered by increasingly popular target-date funds in 401ks—are a natural tailwind for big tech companies that make up a disproportionate amount of the S&P 500, meaning “any rotation out of the heaviest weighted stocks will likely be short-lived.”

So regardless of what Nvidia says Wednesday, investors don’t have to batten down the hatches just yet.

Write to Teresa Rivas at teresa.rivas@barrons.com