Investors should diversify out of AI stocks: Strategist

US Equities (^GSPC, ^DJI, ^IXIC) have been mixed on Monday morning as Wall Street moves into the second half of the year. The first two quarters of 2024 have been dominated by the tech sector and AI names, but can those rallies continue?

Charles Schwab chief global investment strategist and managing director Jeffrey Kleintop joins Morning Brief to give insight into how markets may play out in the second half of the year and whether investors should adjust their positioning regarding AI.

Kleintop says that investors should only pull out of their AI names "when they can see that there are opportunities elsewhere, there are a number of other parts of the market that are much more attractively valued and have increasing earnings momentum. One of the things that we've seen over the last four or five quarters is that AI stocks have driven almost all the earnings gains".

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Nicholas Jacobino

Video transcript

Markets are edging higher to kick off the second half of the year.

That is after an A I fuel rally in the first half, driving two thirds of market gains to discuss what we might see for the second half of this year.

We've got Jeffrey Klein top Charles Schwab's chief Global Investment strategist and managing director, Jeffrey.

Thanks so much for being here.

Look, I feel like we've had this question mark about consolidation evaluations for quite some time now.

At what point do you see that question mark becoming a real risk to this market rally?

You know, we've been fans of, of A I and A I stocks for, for quite a while now.

But we're, we're tempering that enthusiasm actually looking to leadership from sectors like financials and energy and materials in the second half of the year.

You know, a very unique thing happened in the second quarter.

That's only happened five times in the last 30 years and that's the indexes were up on average, but the average stock was down for the S and P 500.

The index was up 4.3% in Q two.

But the average stock in the S and P 500 was down 2.8%.

And that was true around the world.

We can even see it in the all country world index from MS C I.

That was the, the average stock was down 1.7% in Q two.

Even though the overall benchmark itself was up 2.4.

And you're right, it's all about A I and so that increase in concentration of performance in Q two is something we have not seen in a long time.

So yes, A I is outperformed for a while, but it's the only thing seemingly outperforming in Q two.

And I think the risks to the market in Q three tied to that very narrow leadership suggest that investors should look for some diversification out of those handful of stocks.

When can investors know that it's the right time to begin taking profits in their A I trade?

Well, when they can see that there are opportunities elsewhere, there are a number of other parts of the market that are much more attractively valued and an increasing earnings momentum.

You know, one of the things that we've seen over the last four or five quarters is that A I stocks have driven almost all the earnings gains.

In fact, the average stock has seen earnings losses in the last four quarters on a year over year growth basis that changes.

Now we're actually starting to see here in the third quarter earnings, even outside the US.

The earnings for the Euro 600 index or the Euro stock 600 index are expected to grow faster than those in the S and P 500 this quarter.

So you're finally starting to see earnings growth that exceeds that of the US, uh exceeds that of the tech sector outside of that.

And I think that's the turning point here in terms of relative performance.

Jeffrey.

I also want to talk to you about what we're seeing in terms of global elections, obviously following the news of Marine Le Pen's success overnight in France.

Uh but also we are seeing this global push towards more of a populist policy regime.

To what extent could that reverse some of the inflation progress that global central banks have made?

Given some of the policies that do come with populism.

It's a great point when we talk about widespread tariffs and it's not just the US that's talking about increasing tariffs.

Europe has talked about that.

Uh Japan, many countries, Canada are focusing on that.

So when we have multiple barriers to trade and increasing tariffs around the world, well, that certainly does risk higher inflation also a slowdown in the increasing momentum in manufacturing, you know, manufacturing was in recession last year.

We've finally seen a recovery there that's helped lift economies like Germany out of recession.

But the concern is that export growth then begins to weaken for manufactured firms.

So the recovery we've seen and that the, uh the decline in inflation is at risk from populist policies.

We'll have to see how much to actually take root.

Should these populists win?

Uh France will be an interesting referendum on that.

Of course, we've had elections in India and Mexico where we did see populists win and stocks sold off 6% when they reopened.

Uh It will be very interesting to see what happens on Sunday.

And then of course, on July 4th in the UK, when we've got maybe the, uh the, the election going the other way towards the labor party, you know, Jeffrey, as, as we think about the back half of this year, I mean, it really does come back to what the pathway of inflation looks like where employment situation holds up in the dead in, in the um, in the fed's dual mandate here.

All that considered it, it's really just trying to price in when we see some interest rate cuts for the Fed.

You know, how are you looking through their calculus and what they've been signaling thus far, we all year have been penciling in about two rate cuts from the Fed.

So we were way behind when the market was thinking there was going to be six.

And now we, we're thinking that, uh, you know, we're, we're big ahead of the game as the markets pondering whether there will be any at all.

I still think we're going to see the moderation and inflation necessary to get the fed to those one or two rate cuts later this year.

Uh That should begin to weaken the dollar, which is something that should help international investors or, or us based investors investing internationally.

Finally see some of those gains translated back into dollars.

Japan's stock market's up like 18% this year, but in dollars only about 6%.

So getting that stabilization in the currency could be really important in the second half.

Jeffrey Kleintop Charles Schwab, chief, a global investment strategist and managing director.

Jeffrey.

Always a pleasure to grab some time with you.

Thanks for having me.