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The Great Equity Rotation: Into Tech and Away From Retail

NEW YORK (The Street) -- A move away from consumer discretionary stocks and into technology and utilities over the past few weeks lends telling insight into sentiment, fund managers said.

It also paints a complex picture of the U.S. recovery, one where lackluster retail sales hint at cracks in the economy even as risk appetite for sectors such as technology pick up.

Strategists also described the rotation as seasonal, with investors cashing in gains from sectors that outperformed last year as they cast a fresh eye to 2014.

Take consumer discretionary stocks. They posted a stellar 37% return last year as confidence in the economic recovery gathered steam, but have recently faltered, shedding 3.2% so far in January after disappointing holiday sales. Energy stocks returned 19.6% last year but have shedded 2.9% since the start of 2014. Utility stocks appear to be at least briefly back in favor, having notched gained of 1.14% this month after gaining less than 7% in 2013.

Amid the market rout on Friday, investors showed clear risk-off behavior: Defensive sectors such as utilities and telcos were off less than 0.14% while riskier sectors such as technology and consumer discretionary were both shedding more than 1%. 

Yet overall, strategists said strength in small-cap performance and sectors such as the Dow transports -- bellwethers of confidence -- show a solid underpinning for equities.

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"There is more growth in technology vs. other sectors where several stocks have surprised on the earnings front," Schaeffer's Investment Research senior technical strategist Ryan Detrick said in a phone interview. "But retailers show cracks in the economic recovery."

Wells Fargo Securities senior analyst Gina Martin Adams agreed, recommending investors overweight the technology sector to start 2014. "Driven by a recovery in capital spending, we suggest S&P 500 technology sector earnings per share will likely grow 10% this year," she told clients in a note.

On the flipside, Palisade Capital Management Chief Investment Officer Dan Veru said retail stocks were pressured by more than just weak holiday sales. He pointed to a secular shift that was impacting traditional retailers -- the move to online shopping. "The consumer in general is not spending less, but just not in places we would expect like Abercrombie & Fitch (ANF - Get Report) and American Eagle (AEO - Get Report), they go to Amazon (AMZN - Get Report)," he said in a phone interview.

Separately, the CIO noted that interest-rate sensitive sectors such as utilities had enjoyed some respite, after 10-year U.S. Treasury yields tumbled from 3% at the end of December to 2.7% currently, with a bad jobs report underpinning the fall.

"High dividend-paying stocks are relatively more attractive because rates have not risen as people thought they would," Veru said. More broadly, he said he expects sectors such as real estate investment trusts to benefit as rates rise longer term. Pundits say financial stocks are also well-placed for gains as economic confidence improves.

Amid recent wobbles, several strategists predict a more marked rotation to riskier sectors later in the cycle. 

Karyn Cavanaugh, market strategist with ING U.S. Investment Management, said the December cut to bond buying from the Federal Reserve showed that central bankers had confidence in the economic recovery. "Earnings are still going to be strong and we will see more capital spending - companies have been holding back a lot," she said in a phone interview. Cavanaugh said a clearer rotation (toward growth sectors) may occur later in the year, as confidence continued to pick up.

-- By Jane Searle in New York 

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