By Barbara Kollmeyer

The chip pullback is ushering in a bumpy market, warn strategists

Hyperscalers may benefit as chip stocks struggle, according to Morgan Stanley strategists.

The once-hot semiconductor trade has seen a cooling in the last couple of weeks, which is not only likely to continue, but usher in a bumpy ride for the overall stock market.

That's according to a team of strategists at Morgan Stanley led by Mike Wilson, who flagged in a note to clients on Monday which sectors they believe are the best bets as that rotation continues.

One near-term play they like is beaten-down hyperscalers, whose prior underperformance they expect was probably telling for the chip pullback to come. The Roundhill Magnificent Seven ETF MAGS, which contains several of the big hyperscalers, is showing a 1.3% loss this year, while the PHLX Semiconductor Index SOX is up 78% despite declines the last two weeks.

Hyperscalers look attractive on the view that investors could see more tempering of capital expenditure, given poor stock performances in the past few months. Recent speculation that Meta (META) could launch a cloud business to sell excess AI computing capacity is adding to that dynamic, as well as the fact that the group has "already gone through their period of underperformance."

"We also believe this cohort possesses attractive optionality within the AI ecosystem: strong core businesses, the ability to participate in/lead the agentic application layer development and implementation, as well as an underappreciated cost-cutting lever," said the strategists.

They also offer a cautionary note for the overall market. While the chip-stock pullback is a part of the oscillating performances seen between AI beneficiaries over the past couple of years, the fact that it's happening in some of the big chip companies means investors should expect a "choppy/weaker equity market overall."

The strategists added that consumer discretionary goods companies present the best risk-reward given the fall in oil prices as wallet share shifts from services to goods.

Biotech IBB also stands out, with Wilson and his team flagging it as one of the most rate-sensitive market areas - historically seeing nearly 20% annualized returns in elevated and falling rate regimes.

"Given our view that policy rate expectations remain overly hawkish this year in the context of our house call for core CPI to stay contained below 3%, we think biotech offers an attractive risk/reward opportunity," they said.

-Barbara Kollmeyer

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.