Bank of America has made a significant shift in its sector outlooks, reflecting the changing economic landscape and investor sentiment. The firm has raised its rating for Utilities to ‘overweight’, while simultaneously downgrading Energy to ‘market-weight’. This move underscores the impact of heightened volatility and policy uncertainty on investment strategies.
Savita Subramanian, Bank of America’s head of U.S. equity strategy, explains that the evolving economic and political landscape has altered the risk-reward profiles of these key sectors. She highlights that utilities, traditionally considered a defensive sector, are becoming increasingly appealing in the current interest rate environment.
Subramanian argues that utilities, as represented by the Utilities Select Sector SPDR Fund (XLU), offer stability and a hedge against inflation. They are particularly attractive due to their higher dividend yield, which has become more appealing given the revised outlook for interest rates. Bank of America economists now predict that terminal interest rates will reach 3.25% by 2025, a lower projection than previous forecasts. This environment favors income-generating assets like utilities.
Furthermore, utilities are increasingly benefiting from the integration of artificial intelligence (AI) technologies. This presents a new avenue for growth, as companies within the sector adopt AI to improve efficiency and operations. Subramanian emphasizes that utilities are not just a defensive play but also an indirect beneficiary of AI, adding to their attractiveness.
On the other hand, Bank of America’s downgrade of the Energy sector, represented by the Energy Select Sector SPDR Fund (XLE), stems from concerns about political risk and weakening fundamentals. While energy companies have improved their quality and financial discipline compared to previous cycles, the sector faces growing uncertainty.
Subramanian cautions that the supply discipline that has supported oil prices could be disrupted by potential changes in the political environment. This coincides with Bank of America’s commodity strategists lowering their oil price forecasts, casting doubt on the sector’s future growth prospects. She notes that energy stocks, while appearing cheap, could be ‘cheap for a reason’.
One of the most worrying signals for the energy sector is its earnings revision ratio. Currently, Energy holds the ‘most negative earnings revision ratio of all sectors,’ indicating that analysts are increasingly pessimistic about future earnings growth. The sector’s strong performance in recent years could turn into a liability if political winds shift, particularly with potential regulatory pressures like changes in drilling policies and climate regulations.
Meanwhile, Bank of America remains cautious about the Information Technology sector, maintaining its ‘underweight’ rating despite recent selloffs that might suggest a buying opportunity. Subramanian emphasizes that tech stocks still trade at record valuations, particularly in terms of enterprise value to sales (EV/Sales), making the sector vulnerable to further decline.
She argues that technology is cyclical, not secular, meaning its performance is tied to broader economic trends. This makes it susceptible to downturns, contrary to some investors’ expectations of its immunity.
Another concern for the tech sector is the upcoming changes in Standard & Poor’s index cap rules, which could impact the largest technology companies. These changes could introduce concentration risk, leading to passive selling that might pressure some of the sector’s mega-cap stocks.
