Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, notes investors anticipating further gains have experienced a challenging four months. Since October, the tech sector within the S&P 500 has declined by approximately 9 per cent, while energy and materials sectors, previously underperforming, have surged by around 24 per cent. This has catalysed trend reversals, with the equal-weighted S&P 500 outperforming the capitalisation-weighted index by nearly 600 basis points in 2026, and value stocks exceeding growth stocks by roughly 800 basis points. Small-cap stocks have also outpaced large-cap stocks by almost 700 basis points. Morgan Stanley is a global financial services firm that provides a wide range of investment banking, securities, wealth management and investment management services. Morgan Stanley Wealth Management offers financial advice and brokerage services to individual investors and small businesses.
Shalett acknowledges investor concerns regarding negative free cash flow growth and potential declines in return on asset levels as hyperscaler capital expenditure accelerates. However, she emphasises that these companies remain fundamentally strong. Revenue growth expectations for mega-cap tech companies have reached a multi-decade high of 18 per cent. Moreover, the ‘magnificent seven’ stocks are trading at a forward price/earnings multiple of 27, which is below the bull market average. According to Shalett, the tech sector appears to be undergoing a factor rotation away from quality and towards pure momentum.
While acknowledging the low-quality nature of the small-cap rally, Shalett suggests it is now opportune to reduce exposure to that trade in favour of quality stocks. She recommends focusing on earnings realisation in the US and taking profits from small/micro-cap and speculative equities. The advice is to redeploy capital into large-cap core and quality names, including the magnificent seven, and broadening to GenAI productivity beneficiaries in software, financials, healthcare and energy.
For passive investors, Shalett advises balancing market-cap- and equal-weighted exposure, while utilising active management for up to 50 per cent of allocations. She also suggests increasing exposure to rest-of-world equities, with a specific focus on emerging markets. Hedge funds, gold, and infrastructure should remain key allocations within a diversified investment portfolio.
