ETFs
Should Investors Diversify Away From Tech? ETFs to Consider – July 11, 2024
After an incredible rally in the markets in the first half of the year, driven by an AI frenzy and significant growth in the tech sector, investing heavily in technology or following a momentum-driven investment approach seems to be paying off. This is evidenced by the performance of the S&P 500 Information Technology Index, which has gained 49.38% over the past year.
However, investing heavily in the tech sector to capitalize on AI’s growth potential comes with increased concentration risk. If the AI-fueled stock market bubble bursts, the portfolios of investors heavily reliant on technology could suffer significant losses, making diversification a wise choice.
Is a stock market crash on the horizon?
According to Capital Economics, cited by Business Insider, the AI-generated stock market bubble is expected to burst in 2026. High interest rates and persistent inflation levels would weigh on stock valuations, eventually leading to a correction.
According to Peter Berezin, chief global strategist at BCA Research, quoted by Business Insider, the market is expected to collapse 32% in 2025 due to the Fed’s failure to avert a recession. Often considered one of the most pessimistic strategists on Wall Street, Berezin’s projections lean toward the extreme side of bearish forecasts.
Berezin’s pessimistic outlook is based partly on the belief that the Fed will be slow to cut interest rates due to excessive caution. However, while a recession in the U.S. market seems unlikely, the Fed’s hesitation could lead to a fall.
Why High Interest Rates Could Stay
With AI heavily reliant on capital inflows, high interest rates could make the tech sector particularly vulnerable, strengthening the case for diversification out of tech.
Even if the Fed cuts rates, it seems unlikely that interest rates will return to pre-pandemic levels. High interest rates could become the new normal as increased global investment drives demand for borrowing, increasing the need for higher interest rates.
As global investment increasingly focuses on tackling climate change, interest rates could remain high due to the huge investment demand for the transition to a green economy. The rapid adoption of AI supports this view. While it improves productivity and reduces costs, some economists suggest that it could increase borrowing demands due to high capital requirements, which could lead to higher interest rates.
ETFs to consider
The AI frenzy will drive market gains, but the risks of high valuations and concentrated rallies in certain names leave the market vulnerable to deeper drawdowns, requiring portfolio diversification.
Adjusting excessive exposure to mega-cap tech stocks may seem painful in the short term, but will help long-term investors reduce risk while maintaining growth potential.
Below, we highlight a few areas where investors can increase their exposure, diversifying their investments beyond technology for broader market participation. This strategy aims to ensure stable long-term returns and mitigate the risks associated with the bursting of an AI-powered stock market bubble.
Value ETFs
Value stocks have a long-term trajectory of outperformance and resilience to market trends. Characterized by strong fundamentals such as earnings, these stocks trade below their intrinsic value, representing undervaluation. They offer the potential for higher returns and lower volatility compared to growth and blend stocks.
The three funds mentioned below have minimal exposure to the technology sector, offering investors a solid option to diversify and protect their portfolios against downside risk.
Vanguard Value ETF (Quick Quote VTVVTV – Free report) has double-digit exposure to the financial (20.16%), healthcare (16.28%) and industrial (15.21%) sectors.
iShares Russell 1000 Value Exchange Traded Fund (ETF) (Quick quote from JIF)JIF – Free report) has double-digit exposure to the financial (21.29%), healthcare (15.35%) and industrial (14.29%) sectors.
iShares S&P 500 Value Exchange Traded Fund (IVE Quick QuoteIVE – Free report) has double-digit exposure to the financial (23.19%), healthcare (17.88%), industrial (11.28%) and consumer staples (10.24%) sectors.
Equal Weight ETFs
These funds offer sector diversification by assigning equal weighting to each constituent stock, regardless of market capitalization, thereby reducing concentration risk. They are therefore a relevant choice for investors seeking diversified exposure across sectors.
Invesco S&P 500 Equal Weight ETF (Quick Quote RSPRSP – Free report) has gained 11.57% over the past year.
ALPS Equal Sector Weighted ETF (Quick Quote EQLEQL – Free report) has gained 15.23% over the past year.
Invesco S&P 100 Equal Weight ETF (Quick Quote EQWLEQWL – Free report) has gained 18.38% over the past year.
Gold ETF
In times of economic uncertainty, such as a recession, gold attracts more investors because of its enduring value. Often considered a safe haven investment, as bond, stock and real estate yields decline, interest in gold increases, driving its value up.
Gold maintains its purchasing power, contributing to significant diversification of an investment portfolio due to its historical tendency to have a negative correlation with other asset classes. Investors can enhance diversification by combining both value and equal-weight ETFs with gold ETFs.
SPDR Gold Shares (Quick Quote GLDGLD – Free report) gained 5.16% over the three months.
iShares Gold Trust Fund (Quick quote from the IAUUAI – Free report) has gained 5.20% over the past three months.
ABRDN Physical Gold Stock ETF (Quick quote SGOLSGOL – Free report) has gained 5.22% over the past three months.
Investors can think of precious metals ETFs as ETF Basket of Physical Precious Metals Stocks abrdn (Quick quote GLTRGLTR – Free report) And Invesco DB Precious Metals Fund (DBP Quick QuoteDBP – Free report) for additional diversification benefits.