How to keep your portfolio balanced amid AI trade reversals

As part of Yahoo Finance's FA Corner, Manulife John Hancock Investments co-chief investment strategist Matt Miskin sits down with The 8:30 team to evaluate the health of Big Tech stocks as the AI trade continues to dominate sector narratives.

if you look at futures this morning, we got uh we got uh indications for a pretty pretty sharply lower open, particularly when it comes to the Nasdaq. So, those companies are definitely not saving the AI sentiment out there, especially with the spending that meta has planned. So, let's talk about it. What do you do from an investing perspective with all of this information and with everything that's been going on for the past couple of weeks. Let's bring in Matt Mitkin to talk about it.

Menu life John Hancock Investments, co-chief investment strategist for this week's FA Corner brought to you by Capital Group. Matt, it's great to see you and I'm so glad you're here because it has been a really tumultuous few weeks, especially for the tech trade and you know, meta coming out talking about more spending here. We still are going to hear from the uh hyper scalars. I'm sure they're going to be spending a lot. So, how are you thinking about the sell off and and kind of how you position yourself after all this has been going on?

Yeah, we're just trying not to be overly concentrated on the AI trade and it's hard. Right now every index on the planet is basically an AI index from emerging markets is now 50% in tech, semiconductors are the most in history. Uh even US large cap value is 20% tech. So it used to be, oh, I can go to value. It's hard to do because the top three stocks are basically massive tech companies.

Uh so we're moving down in cap. We are positioned more in value, but we're trying to find other ideas. Healthcare is one of our favorites right now. It's gaining relative strength. The earnings are going to beat estimates in our view. It's in defensive equities are starting to get a bid. and what I like about right now is we're getting to see the cards of what happens to markets when this AI trade reverse. Bonds are getting a bid, defensive equities are getting a bid. So to us, those are the things that can really help balance out a portfolio.

Matt, Jake here, you you write to us this is an accountant's most hated market, which is a great term for what's going on. We look at all the the really confusing financing and AI. And so if you're an investor who does want to be in the tech trade, who does want to get some of that potential upside, how do you sort through where the risk is legitimate versus where the risk might be overblown or underappreciated?

Yeah, the hyperscalers are tough and you know, right now, one of the old adages is kind of like earnings are opinion, cash flow is fact. And to your point, financial statement analysis, you're like, oh, this is a red flag, this is a red flag, this is a red flag. And for us, it's tough because right now that is really where much of the other earnings are coming from is that massive cap X boom. We just saw stats that basically 50% of earnings growth for the S&P 500 is AI cap X driven.

Um, so it's just hard again for us, you know, like names like software, uh in the tech space have actually not done as well, um, but actually could be better off here. They could integrate AI and still have some nice earnings and recovery potential after lagging and then other parts of the market that are less sensitive to it. Look, we've got tech. It's hard, you can't just not have tech in this market. It's just so massive.

Um, but in our view, you got to balance it out with some other stuff in the portfolio that is less tech heavy because if we find out that some of these accounting, um, let's say, how do I say this correctly? uh issues are kind of less reliable cash flow, you know, kind of and back in the day, we used to get buybacks from these companies. Those were the good old days. Now they're issuing debt, issuing equity and it's just hard as an investor to sit here and watch that because it's diluting those current investors.

Hey Matt, it's Pross here. You know, we saw GM announce a $20 billion share repurchase plan. so maybe there's some hope there for that. But you know, just talking about the general marketing, the broader market here in generally speaking, you know, obviously today's not looking too good. Uh we've had sort of some pickups recently. What's sort of your sort of take on the broader market? Is it sort of a time to sort of dabble here and there or is it people should kind of be careful?

Yeah, so we're, you know, defensively position and it hasn't been a great, you know, positioning for much of this year. At the beginning of the year, really, it was the best performing stuff was non-profitable tech and small caps were ripping and uh actually I came on your show, uh middle of the year and I said there's going to be two massive forces colliding. Higher cost of capital and one of the things we're watching right now is Triple C spreads. They're over 1000 basis points. The lowest credit quality companies right now, if they want money, it costs 15%.

And maybe I'm just a simpleton in terms of thinking about business 101, but your return on invested capital has to be higher than your cost of capital. It's really hard to beat 15%. And so what we're doing is we're trimming small caps, we're trimming high yield, and we're moving up in quality. You know, I think it's hard to not own equities, but if you do so in a risk managed way, that's the best way to get through this and look, we've got five to 6% bonds and no one wants them. They're the least popular thing on the planet Earth.

That's not a bad alternative if you do want to take some cash and or take some profits off the table here and get a nice income stream.

Yeah, that's what I wanted to ask about Matt because I know you guys were you guys were, were bullish on bonds for a while before it was cool. Um and um, you know, and there are more people coming in now and saying you want to nibble in uh in the treasury market. Do you think we have seen peak yields?

So it looks a lot like 2018 to me Julie and really what we saw was a fiscal stimulus in the middle of an economic cycle causes a backup in bond yields. Lo and behold when you give fiscal stimulus in and you juice the economy, it keeps it pushes rates up. Um, but in 2018, the last time we had stimulus like this was the tax cut and jobs Act. 2017 is it was put into place, 18 it got um more into the economy and low and behold, October is the worst month of the year for bonds.

And in 2018, bond yields peaked out in October. Um it's back then it was 3% was the threshold. It was like bounce when over 3%, 3% feels so low relative to where we are five today. Um but I wouldn't be surprised actually if the Fed is being really hawkish now and actually is cutting next year. 2018 the Fed hiked, 2019 they cut and it was the same story where we did fiscal stimulus to juice the economy and then we got an air pocket the next year.

The Fed had to actually ease a bit in the subsequent year. It also caused the market rotation into more defensive, higher quality companies. That might also be a story of 2027.

Matt, zooming out for just a second here and kind of to what you were just talking about. Uh one of the themes I've been watching is kind of the re-emergence of geopolitics as a real market force this year, whether you're talking about the war in Iran or you know, what's going on in France with the French debt or any of these dynamics we're seeing kind of open up. When you're talking to investors, how are you telling them to balance maybe some of the geopolitical headwinds we could see and some of the risks there against just looking at the US market staying solid and figuring out where you want to go from here?

Yeah, so we do have the midterms coming up uh and to us it's, you know, like, look, there's always geopolitical events. There's always going to be things, you know, that's a wall of worry. It's like Mount Everest right now in terms of the wall of worry and we've got one of the strongest Sherpas in the planet's history in earnings. And so what we are talking about is earnings, follow the earnings. Again, we talked about, you know, look, it's accounting, we've got to be careful on it. I get that.

Um but at the end of the day, look, we've got the big fiscal package we were probably going to get this whole cycle. It is more mid cycle, it caused higher rates. Um we've gotten much of that, you know, again, earnings improvement on that. I think really fiscal and government and kind of the geopolitical backdrop diminishes into 2027, at least is a positive. Um but you know, you go back prior to kind of the conflict in Iran in February, the 10 year treasury yield was 3.96%.

Wow. If we went back to that, bonds would be in double digits. So, you know, and look, the inflation backdrop too, because you're doing all this stimulus, it keeps inflation more stubbornly sticky. Well, oil prices will lap these levels in March of next year. So energy inflation almost mathematically is going to diminish into March and kind of the second quarter of next year. If you did get some disinflation, the Fed and I, you know, as much as the geopolitical events is what a lot of investors look at, we constantly try to turn to the Fed and earnings.

If the Fed can kind of take their foot off the break, that'd be a nice relief valve uh for 2027.