As we head into the second half of the year, Bank of America warns investors about the potential pain trade related to the reversal in Big Tech stocks. The first half of the year saw a significant surge in mega-cap technology stocks, with CNBC’s Magnificent 7 index gaining over 36% from January to June. However, in July, there was a rotation out of these tech stocks in favor of small caps due to hopes of potential easing in monetary policy by the Federal Reserve. The Russell 2000 index surged 10% during the month while the Nasdaq Composite ended July lower by about 0.8%. It is important for investors to be cautious of a further rotation out of tech stocks, especially if AI monetization dwindles. Analysts at Bank of America believe that AI may transition from a ‘tell me’ to a ‘show me’ story, with companies needing to demonstrate revenue generation from their investments in AI. Investors banking on tech stocks without significant monetization may be at risk of de-risking.

Neglecting Cyclical Exposure

Another pain trade highlighted by Bank of America is the danger of neglecting cyclical exposure in the current market environment. Despite softening economic data, the firm believes that long-only funds should not have an extreme lack of exposure to cyclical stocks. Opportunities for increased exposure in sectors like energy, materials, and financials are present, as these sectors have rallied in 2024, gaining more than 11%, 7%, and 16%, respectively. In a scenario of a soft landing with slowing inflation and easing rate pressure, cyclicals are expected to perform well. Bank stocks, in particular, are seen as overlooked by investors and present an opportunity for increased exposure.

Overlooking Dividend Plays

Investors can also potentially overlook dividend-paying stocks as a pain trade for the remainder of the year, according to Bank of America. Despite record inflows into bond funds in 2024, the firm sees more opportunities in dividend stocks for investors searching for yield. More than 200 S & P stocks currently provide a higher real return potential than the 2% offered by the 10-year Treasury, after accounting for taxes and inflation. However, 75% of these stocks are considered underweight in long-only funds, indicating a potential opportunity for investors to increase exposure to dividend-paying stocks. Bank of America expects dividends to play a larger role in total returns going forward than price returns and multiple expansions seen in the past decade. The SPDR Portfolio S & P 500 High Dividend ETF (SPYD) has already surged 10% year to date and more than 7% in the past month, indicating the potential for strong performance in dividend stocks.

Investors should be vigilant of these three pain trades as we move into the second half of the year. Reversals in Big Tech stocks, neglecting cyclical exposure, and overlooking dividend plays all pose risks to portfolios, and it is crucial for investors to reassess their positions and consider making the necessary adjustments to navigate these potential pitfalls. By staying informed and proactive, investors can position themselves to weather these pain trades and capitalize on opportunities in the market.

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