Why financials may become the ‘new crowded’ sector after looming classification changes in stock market

Financials and technology will see “big changes” that affect fund manager positioning as some S&P 500 stocks are set to switch sectors, according to a BofA Global Research note Tuesday. After the changes are made, financials could become “the new crowded sector,” BofA equity and quant strategists suggested in the note.

The GICS changes will shift long-only funds and hedge funds to an overweight position in financials, from underweight, as “growthier payment processing companies” will be added from the tech sector, BofA equity and quant strategists said in the note. They cited Visa Inc.
V,
-1.76%,
Mastercard Inc.
MA,
-2.07%
and PayPal Holdings Inc.
PYPL,
-3.29%
as examples of the growthier companies that will be added to financials.

Meanwhile, long-only funds will “shift to an underweight in information technology” while hedge funds will “deepen their underweight,” the strategists said.

The new tech-sector weight in hedge fund holdings relative to the S&P 500 will fall to a 23% underweight from a 6% underweight, the BofA note shows. And long-only funds’ holdings in tech will fall to a 4% underweight from equal weight.

As for financials, the new relative weight for long-only funds will rise to a 4% overweight, from a 6% underweight, according to BofA. The weight of financials in hedge fund holdings will jump to a 21% overweight relative to the S&P 500, from a 10% underweight, the note shows.

Read: ‘Slim majority’ of actively managed U.S. large-cap equity mutual funds fail to beat S&P 500 in 2022

In the view of Wells Fargo Investment Institute, the “most important change” in the evolution in sector classification is that companies such as payment processors and certain business-process outsourcing firms will shift from the information technology sector into financials and industrials. But the classification changes “do not impact our current equity sector guidance,” Wells Fargo said.

Tech is the best-performing sector of the S&P 500 this year through Tuesday, according to FactSet data. 

Shares of the Technology Select Sector SPDR Fund
XLK,
-1.76%
have soared almost 12% so far this year, FactSet data show, at last check. By contrast, the Financial Select Sector SPDR Fund
XLF,
-1.82%
was up 2.6% year-to-date based on Tuesday afternoon trading, while the Industrial Select Sector SPDR Fund
XLI,
-1.86%
was up 4% so far this year. 

Meanwhile, the U.S. stock market closed sharply lower Tuesday, as investors considered the hawkish tone of comments made by Federal Reserve Chair Jerome Powell in his congressional testimony. The S&P 500
SPX,
-1.45%
fell 1.5%, trimming its gains so far this year to 3.8%, according to FactSet data.

Read: Powell leaves door open for faster pace of interest rate rises at March meeting