Tech companies dominated the stock market over the past decade, but with stubborn inflation forcing the Federal Reserve to aggressively raise interest rates, their reign may be coming to an end. “Bear markets have historically resulted in leadership change,” wrote Bank of America equity strategist Savita Subramanian in a Wednesday note, “which suggests old economy sectors are likely the winners of this cycle.”
After years of the Fed’s zero-interest rate policy (ZIRP) fueling speculative investments in tech firms that were able to use cheap debt to finance rapid growth, the era of “free money” is over, according to the bank.
Interest rates will likely stay “higher for longer,” Subramanian argues, which means investors should look to sectors that represent “the old economy” including energy, materials, and industrials. “The old economy has been starved of capital for 10+ years, whereas tech has enjoyed free money. With the end of ZIRP, we see the pendulum swinging back to the old economy as prolonged underinvestment has led to supply issues,” she wrote.
After tech stocks’ brutal year in 2022, the sector rebounded sharply in January as stronger than expected labor market data and fading inflation boosted investor confidence. But this month has been a different story, with the tech-heavy Nasdaq sinking nearly 5% since Feb. 2. Even after the drop, Subramanian warned Wednesday that growth-focused tech stocks still aren’t pricing in the risk of a recession or higher interest rates.
As a result, sectors that represent the old economy like commodity producers and even homebuilders trade at a “record discount” compared with the S&P 500 based on equity risk premium—which is derived from subtracting the real interest rate on the 10-year Treasury from a given sector’s trailing price/earnings ratio.
Still, Subramanian warned that the overall stock market remains overvalued. The S&P 500 currently trades at more than 18 times forward earnings, which is 20% above the last decade’s average. And just four out of 10 of Bank of America’s bull market signposts—which flash when a new bull market is set to begin and include things like interest rate cuts and investor sentiment surveys—have been triggered this month.
Subramanian also explained that while the latest “robust economic data”—including the strong January retail sales and jobs reports—may have delayed the timing of a recession, it also means inflation could reignite, leading to more interest rate hikes from the Fed.
Bank of America chief U.S. economist Michael Gapen has warned investors of the potential for recession as a result of rising interest rates since he started the job last July. And despite signs of resilience in the labor market, he doubled down on the forecast last week in a note to clients, calling for a “mild recession” sometime this year.
Against this backdrop, some investors have argued it may make more sense to invest in U.S. Treasuries, which now offer a real yield, and avoid stocks. The billionaire “Bond King” Jeffrey Gundlach said Wednesday that he’s preparing for a recession at DoubleLine Capital, which manages roughly $100 billion in assets, by holding less risky investments like Treasuries.
“I always say, ‘Don’t listen to what I say, look at what I do.’ And we started de-risking, if you will, in the fourth quarter of 2021,” he told Yahoo Finance.
Morgan Stanley chief investment officer Mike Wilson also warned last week that stocks are in the “death zone,” and he expects the S&P 500 to drop more than 20% to the low 3000s before a recovery into the end of the year.
This story was originally featured on Fortune.com
More from Fortune:
5 side hustles where you may earn over $20,000 per year—all while working from home
Millennials’ average net worth: How the nation’s largest working generation stacks up against the rest
Looking for extra cash? Consider a checking account bonus
This is how much money you need to earn annually to comfortably buy a $600,000 home