The great sector shake-up

By Lilian Chovin, Head of Asset Allocation

• Sector leadership has shifted repeatedly in 2026, driven by sentiment around technology valuations and geopolitical uncertainty instead of changes in company performance.
• Despite these rotations, earnings forecasts for major technology firms remain robust, highlighting why solid fundamentals, not short‑term sentiment, could be the more reliable guide for long‑term investing.
• With the economy still expanding, our stance is unchanged – we favour sectors with sustainable earnings and remain overweight equities, while maintaining diversification through a suite of assets.

Market leadership has shifted repeatedly so far this year, with technology initially falling out of favour before geopolitical uncertainty prompted a partial reversal. These moves, however, were driven largely by sentiment around valuations rather than changes in underlying company performance.

Valuation-driven adjustments can happen quickly, but they are typically limited – unless fundamentals change. Earnings growth, by contrast, can build steadily over time, making it a more dependable driver of long-term investment returns.

This distinction helps explain the disconnect seen this year between share price performance and company earnings. While sentiment towards technology stocks has fluctuated, earnings expectations for the sector have continued to rise, reinforcing its role as the primary engine of index level earnings growth.

For long-term investors, this underlines the importance of remaining anchored to fundamentals, even when short-term market moves appear dramatic. The next earnings season starts this week – in which companies report their performance for the first quarter of 2026 and share guidance on future earnings. Those are the numbers worth particular scrutiny in our view.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

There and back again  

In February, before the Middle East situation deteriorated, investors started questioning the valuations of large technology companies driving the development of artificial intelligence (AI). Concerns centred on the industry’s substantial capital expenditure plans for 2026 – estimated at around $600 billion.

As a result, investors revised down how much they were willing to pay for those stocks, negatively impacting the sector’s returns. Capital flowed instead into cyclical sectors, seen as being supported by resilient economic data and cheaper valuations.

Then, as geopolitical tension rose, investors took some solace in the more resilient, ‘quality defensive’ characteristics of established technology firms. As a result, the technology sector has held up better than the overall market since the Middle East conflict began. It was still down 3.8% in March, but the overall S&P 500 fell around 5%.

The only sector to hold up meaningfully throughout March was energy, where uncertainty around supply pushed oil prices higher – at its March peak, Brent crude reached $118 per barrel for the first time since the Russian invasion of Ukraine in 2022. This meant that the S&P 500’s energy sector rose around 40% in the first quarter of 2026.

A sentimental journey

Our analysis demonstrates how much of this year’s sector volatility has been dictated by sentiment. Sector returns are driven by two main forces – changes in earnings expectations, a reflection of how well companies are doing, and changes in price‑to‑earnings multiples, a reflection of investor sentiment. Earnings tend to shape long‑term returns, while multiples are a key source of short‑term volatility.

By the end of March, year‑to‑date sector performance across the S&P 500 closely mirrored changes in relative price‑to‑earnings multiples, not changes in earnings forecasts, showing that sector performance reflected investor sentiment.

The rotation away from AI-related businesses in February was based on a valuation re-think due to the returns required to justify huge spending plans. While investors’ subsequent return to technology was driven by precaution around the Middle East conflict. The underlying fundamentals were not part of the story.

In fact, earnings expectations for the technology sector have been consistently revised higher throughout. By the end of the first three months of 2026, earnings growth expectations for technology had risen 9% compared to the start of the year, according to S&P Global – the largest rise of any sector. And that’s despite software company stocks dropping significantly due to concerns about AI disrupting their business models. 

Our long-term view remains intact

While we continue to monitor the potential consequences of developments in the Middle East, we currently do not see a reason to alter our investment positioning. The global economy entered the conflict from a position of strength, backed by robust growth, benign inflation and solid company earnings. Our analysis indicates that the global economy is still in an ‘expansion’ phase.  

Our stance therefore remains constructive. We are overweight equities relative to developed market government bonds, with a preference for emerging market stocks which we believe offer strong operational performance and promising earnings growth. But mindful of risks, we keep our investments diversified through a suite of assets that includes liquid alternatives, gold and currency hedging, as well as bonds.