Navigating Sector Rotations: Key Insights for Financial Advisors

By TMC Research Staff | The Milwaukee Company | tmcresearch@themilwaukeecompany.com

As the third quarter of 2024 draws to a close, the financial landscape has been marked by evolving inflation trends, Federal Reserve monetary policies, and sector rotations. Many Financial advisors are observing a delicate balance between potential rate cuts and a slowing economy, presenting new considerations for portfolio management. Understanding these sector rotations and identifying potential opportunities in various industries can help advisors attempt to better position their clients’ portfolios in a dynamic environment. However, it is important to emphasize that these insights are not recommendations but rather considerations to help guide decision-making based on individual circumstances.

Inflation and Interest Rate Dynamics: Context for Portfolio Adjustments

In 2024, inflation has moderated from its peak in 2022, when it surged to multi-decade highs. By August 2024, the inflation rate had declined to 2.5%, to its lowest level in over three years. Yet, core inflation, driven by factors such as rising rent prices and lingering supply chain disruptions, remains elevated in certain areas. This environment presents challenges for financial advisors as they assess the potential impact of inflation on various sectors.

The Federal Reserve has transitioned from aggressive rate hikes to a more cautious approach, with the expectation of incremental cuts aimed at fostering a “soft landing” for the economy.

However, these cuts are not guaranteed to produce immediate market benefits. Advisors may want to consider the potential risks and opportunities presented by this gradual reduction in rates, recognizing that sector performance will vary based on how interest rates evolve.

Sector Rotations: Opportunities and Risks to Consider

Moderating interest rates and inflation have set the stage for sector rotations. As certain industries adapt to these changes, financial advisors can evaluate which sectors may offer growth potential and which might face headwinds. Below are key sectors that may experience shifts and could warrant further analysis in portfolio reviews.

1. Technology: A Sector in Transition

The technology sector has been a dominant force in market growth over the past decade, particularly driven by the surge in artificial intelligence (AI). However, by mid-2024, the fervor around AI stocks has shown signs of cooling​. While companies like Nvidia and Alphabet have benefited from this wave, advisors might consider reassessing their exposure to AI-driven stocks, particularly as valuations stabilize.

Diversification within the tech sector could help mitigate risks. Sub-sectors such as cybersecurity, digital infrastructure, and cloud services are expected to continue growing as businesses increasingly prioritize securing data and optimizing operations in a digitized world. For advisors, this means evaluating opportunities within a broader range of technology investments rather than focusing solely on high-growth AI firms.

2. Energy and Commodities: Defensive Considerations

Energy stocks have demonstrated resilience throughout 2024, even as inflation begins to cool. The sector continues to benefit from volatile oil and gas prices, which are generally influenced by geopolitical factors and supply chain disruptions. For advisors, energy stocks may serve as a potential hedge against broader market risks, particularly in periods of inflationary pressure.

Additionally, the energy transition toward renewables offers potential long-term growth. Clean energy investments, such as solar, wind, and electric vehicle infrastructure, are gaining traction as governments and corporations seek to reduce carbon footprints​. Advisors might evaluate these trends for clients with a longer investment horizon, though it is important to consider the varying risk profiles associated with renewable energy stocks, as well as potential changes in the political climate surrounding clean energy.

Commodities like gold and silver also present defensive plays in uncertain markets. These assets have historically performed well during periods of volatility, and with central banks worldwide adjusting monetary policies, gold, in particular, has regained its appeal as a store of value​. Advisors could consider incorporating commodities as part of a diversified strategy, though this should be tailored to clients’ specific goals and risk tolerances.

3. Consumer Discretionary: Assessing Resilience and Risks

In 2024, consumer discretionary stocks have shown resilience, bolstered by strong household spending despite inflationary pressures. Sectors such as luxury goods, travel, and entertainment have rebounded from pandemic-related declines, driven by pent-up demand from higher-income consumers. Advisors may want to explore opportunities in companies with strong brand loyalty and pricing power, as these characteristics could support profitability in a potentially slower economic environment.

That said, as the Federal Reserve’s rate cuts progress, consumer spending patterns may shift. Advisors should consider the possibility of a reduction in the “wealth effect,” where higher asset prices lead to increased consumer spending​. As such, it may be prudent to monitor how rate cuts affect more price-sensitive segments of the market and adjust exposure accordingly.

Diversification as a Risk Management Tool

Given the uncertainty around inflation, rate cuts, and economic growth, diversification remains a crucial element of risk management. Advisors might focus on balancing growth-oriented sectors, such as technology and consumer discretionary, with more defensive positions in fixed income and international equities.

As the U.S. dollar weakens slightly due to lower interest rates, emerging markets and other non-U.S. assets could offer attractive potential avenues for diversification opportunities​. These markets often have lower correlations with U.S. equities and could potentially benefit from more favorable growth conditions. Additionally, high-quality bonds, particularly investment-grade corporate bonds, may offer stable returns as rates decline​.

Preparing for 2025 and Beyond: The Importance of Flexibility

Looking ahead, financial advisors should remain vigilant in monitoring both domestic and global economic developments. While the Federal Reserve aims to engineer a soft landing, external risks—such as geopolitical conflicts or unexpected shifts in inflation—could disrupt this plan. Advisors are encouraged to remain flexible, adapting portfolios to reflect changing market conditions and client objectives.

Long-term trends, such as decarbonization, technological innovation, and demographic shifts, will continue to influence market dynamics. Staying attuned to these trends and adjusting sector allocations as necessary could help advisors position client portfolios to capitalize on emerging opportunities while managing risks.

In conclusion, the evolving economic landscape of 2024 presents both opportunities and risks for financial advisors. Sector rotations, driven by changing inflation and interest rate trends, require careful consideration of how portfolios are allocated. Advisors should focus on understanding these rotations, exploring growth sectors like technology, energy, and consumer discretionary, while also incorporating defensive strategies through diversification.

It is important to note that while these insights provide considerations for portfolio adjustments, they should not be viewed as definitive recommendations. Each client’s financial situation, risk tolerance, and long-term goals should guide decision-making. By remaining flexible and responsive to economic developments, financial advisors can navigate this complex market environment and help clients achieve their financial objectives.

For enquiries contact Michael Willms at mwillms@themilwaukeecompany.com