Utilities pivot sounds alarm for growth stocks

The S&P 500 has spent months churning between 6,700 and 7,000, but a major shift in leadership is quietly changing the market narrative. While technology dominated for years, a move into defensive sectors—specifically utilities, energy, and consumer staples—is sounding an alarm for growth investors.

As the Magnificent Seven struggle to maintain their footing, proprietary data from the Limelight Alpha sector model suggests this isn’t a temporary dip. Instead, we are seeing a fundamental rotation into “risk-off” groups that typically lead during the late stages of the economic cycle.

These groups are driving significant gains for index ETFs with broader exposure, including the Russell 2000 and the Equal Weight S&P 500 (RSP). The performance gap is widening: the Utilities ETF (XLU) is up 8% year-to-date, while the average Magnificent Seven stock has slipped 7%.

The contrast is even sharper for those holding the Roundhill Magnificent Seven ETF (MAGS), which has tumbled 12% from its peak last fall. Meanwhile, the higher concentration of defensive, late-stage stocks has propelled the Russell 2000 and RSP to year-to-date returns of 17% and 11%, respectively.

This aggressive shift in leadership has sparked a critical debate: is this a healthy rotation or a warning of a broader market peak?

Sector model pivot sends cautionary message on what’s next

Limelight Alpha’s multi-factor sector model crunches data weekly to rank baskets more or less likely to reward investors. The ranking has confirmed energy stocks’ dominance since last fall, when rattling sabers raised the possibility of unlocking Venezuela’s massive oil reserves.

Related: Analyst resets Chevron stock price target as oil strategy shifts

It has also pivoted away from technology, ranking below average for weeks, and toward previously under-loved groups, including healthcare, basic materials, staples.

This week, Limelight Alpha’s latest data adds another defensive twist: utilities, a favorite basket among defensive-minded investors, have surged into the second spot in the large-cap ranking, trailing only energy.

Limelight Alpha Large Cap Sector Model:

The pivot isn’t a call to change long-term investment plans. However, it is a signal that should remind investors that stocks don’t go up (or down) in a straight line. Instead, they zig and zag, with many pops and drops along the way, creating risk and opportunities for investors.

What’s driving the shift from technology to defensive sectors

It’s certainly possible that the weakness in technology stocks is simply a speed bump along the way to greater gains down the road.

There’s a good argument that February’s market churn is to be expected, given seasonality suggests February is traditionally a weak link, including during mid-term election years. I wrote more about February being a ‘banana peel’ month here.

It’s not lost on me that we also saw similar doubts hit technology stocks last year, when questions emerged about massive AI spending plans derailing corporate profits. Most stocks recovered strongly through last fall, before struggling.

Instead of a wholesale S&P 500 sell signal, sector rotation may simply reflect a transition to a more discriminating investor as AI interest shifts from “anything at any price” to a focus on who the real winners and losers are.

That would certainly seem to be true based on the performance of software stocks, which have tumbled this year amid fear that agentic AI would dismantle software-as-a-service as we know it, crimping sales and profit growth, and forcing a rerating after years of a higher-than-market valuation driven by the industry’s sky-high margins.

With technology, arguably priced to perfection, including software stocks, accounting for over one-third of the S&P 500, it’s not out of bounds to expect a mindset shift to “prove it” that would lead to erasing some stock market froth.

And then, when you consider companies more likely to benefit from such a shift, defensive groups like energy, healthcare, consumer staples (and yes, utilities) do fit the bill:

• These companies are traditionally weighed down by hefty, fixed costs that AI may conceivably reduce, boosting margins and earnings while technology margins get squeezed by rapidly rising spending plans.
• Utilities stocks are likely to benefit from rising energy demand from all those power-hungry server farms coming online and lower interest rates’ impact on interest expense.
• Healthcare, utilities, and staples stocks tend to perform best in the late stage of the economic cycle, when GDP growth is peaking, and the risk of deceleration emerges, increasing risk-off appetite.

What can investors do now?

The S&P 500 has successfully held around 6750 to 6800 since November. If that changes, then we could see a more substantial retreat toward the 200-day moving average, which rests currently near 6500.

Long-term investors have historically been rewarded for dollar-cost averaging into market weakness, but short-term investors may want to rethink their exposure, especially if they’re using leverage like margin, which can worsen losses.

If this is simply a February swoon, the market should start to head higher soon. The Stock Trader’s Almanac reviewed all mid-term election years since 1949, and typical February weakness tends to end by early March, with the S&P 500 trending up through mid-April before sliding again through summer ahead of the election.

If it’s a signal of something worse, investors will want to keep a close eye on how the S&P 500 behaves if it fails to eclipse 7,000, falls, and retreats to the 200-dma.

In any case, building small starter positions in those defensive sectors, including utilities, may help you diversify some risk if you’re overly exposed to tech stocks.

Overall, if you zoom out, there is some good news: While 2026 appears to be volatile, mid-term weakness has historically presented an intriguing buying opportunity.

“Where there is great danger, there is also great opportunity,” wrote Stock Trader’s Almanac’s Jeffrey Hirsch. “After reaching negative territory in Q2 and Q3 stocks should rally in Q4.”

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