A veteran strategist says a famed recession indicator is signaling underperformance for tech stocks
IPO
- Strategist Jim Paulsen says tech stocks are poised to underperform.
- When the yield curve steepens, tech earnings tend to lag behind the market within 18 months, he said.
- Economic conditions are easing, which can lead to stronger performance in other parts of the market.
The market's most notorious recession indicator is sending investors a new message: tech stocks are about to get left behind.
That's according to Jim Paulsen, a Wall Street veteran and the former chief investment strategist of The Leuthold Group, who said he's eyeing recent moves in the yield curve — the spread between long and short-term US Treasury yields, which has famously predicted every recession since 1955.
The yield curve has steepened in recent months, a sign that investors expect long-term yields to surpass short-term yields. That tends to be a leading indicator that earnings growth in the tech and communications sector is bound to underperform the broader market, with an average lag time of around 18 months before earnings start to fall behind, per Paulsen's analysis.
The market is already seeing stronger performance in other corners. While the information technology sector is still one of the market's best performers, it's been outpaced by gains in energy, up 27% year-to-date, and materials, up 14% year-to-date.
Paulsen said he believes the change in market leadership away from "new era" tech stocks may be fueled by an increasingly accommodative economic environment, which is driving stronger performance across the broader market. In periods when the Fed was hiking rates, new era stocks outperformed other sectors by a wide margin, he noted.
"I'm certainly not positive the yield curve signal highlighted in this report will prove successful. But I think a tilt away from new era stocks toward broader market sectors during the balance of this year, and perhaps beyond, may have merit," Paulsen wrote on Monday.
The yield curve — which predicts an economic downturn when the spread between the 10-year and 2-year Treasury yields is inverted — has been known to produce false positives in its recession forecasts. The curve was inverted from 2022 to 2024, though the US never fell into an official recession.
Still, Paulsen said there are a few reasons investors "should pay attention" to the yield curve and what it means for market leadership.
For one, it's likely that financial conditions will continue to ease, given the economic impact of the Iran war on economic growth. Markets are pricing in several rate cuts by the end of the year, according to the CME FedWatch tool.
The money supply — another measure of how loose financial conditions are — is also growing, Paulsen noted, with the M2 money supply rising 4.8% on an annual basis in March.
Stocks in the broader market outside of tech are also priced at "much more reasonable valuations" and are "extremely under owned," he added.
Other forecasters have recommended that investors shift their portfolios away from tech toward other areas of the market on the basis of valuations. Small-cap, industrial, healthcare, and international stocks are some of the areas of the market Wall Street analysts have recommended lately.