Resist the temptation of AI and bet on safe defensive stocks, Wall Street analysts say

• More analysts are recommending “defensive” shares over AI plays as macro conditions change.
• Utilities, a classic defensive sector, are going toe-to-toe with tech.
• With some questioning the AI rally, investors could benefit from non-tech growth companies, an analyst said.

Defensive recommendations have taken center stage on Wall Street as the artificial intelligence trade shows signs of being overextended and as economic conditions change.

Utility stocks — a common buy when times look tough — have gone toe-to-toe with the technology sector’s blowout performance this year. Year-to-date, the utilities and tech sectors have gained 22.08% and 25.69%, respectively.

Defensive sectors of the stock market, which can also include real estate and consumer staples, tend to be better plays when macro conditions look to be softening. As employment data has weakened in recent months, investors are growing nervous about a coming downturn.

Meanwhile, though the sector has staged a comeback this week, leading AI names have struggled to find their footing, with Nvidia facing tough questions about returns on AI investments by companies. The broader S&P Global Semiconductor Index is down 5.63% for the month.

As the AI trade takes a bit of a breather, and as data shows the economy may be cooling, more analysts are recommending investors take shelter in defensive corners of the stock market.

Bank of America said investors should avoid buying the tech dip, noting that market volatility is set to pick up over the long term. In addition to dividend-paying utilities, it also suggested investors seek real estate exposure.

Similar to BofA’s call, Morgan Stanley’s Mike Wilson last week called the AI theme “overcooked” and said investors should shift to defensive shares.

According to Brad Conger, CIO of investment firm Hirtle Callaghan, some of the S&P 500’s more “boring” companies are at the heart of the defensive theme.

“Our positioning is that there are a lot of great growth businesses that are undervalued because of both the excitement around tech and AI,” Conger told Business Insider, citing things like waste management companies.

The performance of such defensive names would rise dramatically if the US economy took a turn, he added.

“That’s what we’ve seen in the past eight weeks — as the prospect or the possibility of recession has gone from, say, 10% to 30%, then those things got a tailwind.”

Like Morgan Stanley’s Wilson, Conger believes that AI is overstretched and he warned that hardware firms like Nvidia are facing a cliff if the technology doesn’t start to show real returns on investment.

Firms, from BlackRock to Vanguard, agree that timelines need adjusting. JPMorgan noted in a recent report that adoption trends need to move higher if the tech hopes to avoid a “metaverse outcome,” referring to the virtual reality worlds that saw huge investment a few years ago but which ultimately never ended up producing much of a return.

To be sure, most on Wall Street are still convinced by AI’s potential. Eric Diton of Wealth Alliance told BI that Nvidia’s recent drop was a case of profit-taking and not a sign of enduring weakness

“We can’t fathom what this will look like 10 years from now, but AI will become a mainstream part of everyone’s daily life,” the firm’s president said. “There’s no doubt in my mind.”

But in tune with what others had said, Diton also touted that utilities stocks as one meaningful investment to make right now. As bullish on AI as he may be, he warned that the market has become extremely concentrated in tech’s leading names, and investors need to diversify.

“Do you need to have exposure to AI and tech? Absolutely. But do you want to do it in the way the S&P 500 is?” he said. “No,you don’t want to. You don’t want to have 20% of your net worth and three stocks.”

With the Federal Reserve anticipated to cut interest rates at its meeting this week, Diton also suggested that investors pick up high-dividend paying stocks and longer-term bonds. He also shared a preference for small-caps, which can see stronger performance when borrowing costs fall.