Tech Sell-Off Sparks Big Money Shift: Here's Where to Invest

Core Viewpoint - The tech sector is experiencing a shift as investors are increasingly focusing on small and midcap stocks, moving away from mega cap tech dominance, driven by underallocation, reasonable valuations, and better growth prospects in smaller companies [1][2][3][5]. Group 1: Market Dynamics - There is a notable underallocation to small and midcap stocks, currently at about 3% of the Russell 3000, compared to a typical allocation of 7.5% [3]. - The Russell 2500 growth index is trading at approximately 21.5 times earnings, which is below the S&P 500's typical range of 15 to 17 times over the past 20 years [4]. - Small cap stocks are projected to grow at a forward sales rate of about 16%, compared to 11% for the S&P 500, indicating a potential for better growth in smaller companies [5][6]. Group 2: Economic Environment - The current economic environment, characterized by low inflation and potential GDP growth of around 5%, is favorable for small cap stocks [6][7]. - Increased productivity is helping to keep wage-push inflation down, and tariffs have not significantly impacted the market [8]. Group 3: Sector Performance - Investment is shifting from software to hardware and semiconductor sectors, particularly benefiting companies involved in AI data center buildouts, with capital expenditures expected to rise from $200 billion in 2024 to $650 billion in 2025 [11][12]. - Software companies are facing challenges, with an average decline of 20% year-to-date and a 40% drop in small cap software over the past year [12][13]. Group 4: Investment Opportunities - Companies like Data Dog and Dinatrace are highlighted as strong investments due to their embedded roles in network infrastructure and high free cash flow growth [15][16]. - In healthcare, companies like Tempest AI are leveraging AI for cancer diagnostics, creating unique databases that enhance drug development [21][22]. Group 5: Broader Market Implications - A broadening market, with increased investment in small and midcap stocks, is seen as healthy for the overall economy, potentially benefiting consumer spending [30][31]. - The disconnect in valuations between small and large cap stocks is historically significant, suggesting potential for growth in the small cap sector [32].