Stock Traits to Prioritize When Rotating Out of Risk: Expert Guide

After February’s sharp sell-off in many software names amid renewed AI-driven valuation concerns, investors are rotating out of higher-risk, momentum-driven stocks toward companies with steadier cash flows and stronger balance sheets, CIBC Capital Markets’ Chris Harvey said. His guidance on the traits to prioritize in this rotation — recurring revenue, free cash flow generation, low earnings volatility, and resilient margins — frames how portfolio managers are repositioning ahead of an uncertain Federal Reserve narrative.

CIBC (ticker: CM) operates globally through commercial banking and capital markets franchises; CIBC Capital Markets is the bank’s institutional research and trading arm. Harvey, managing director and head of equity & portfolio strategy, is widely followed by institutional clients for macro and equity allocation views. His comments come after a volatile stretch for technology and software shares that captured much of February’s market attention.

The trigger for the recent shift was a sell-off in software stocks that investors attributed to a reassessment of AI-related growth expectations and frothy multiples. Many high-growth software names saw double-digit pullbacks at that time, squeezing momentum strategies and prompting a broader reassessment of exposure to high-beta sectors. For allocators, the move highlights the risk of concentration in narrative-driven winners and the appeal of more durable business models.

Harvey outlines a set of stock traits investors should prioritize when rotating out of risk:

• Recurring and contractual revenue: Subscription models reduce top-line volatility and support predictable cash flow conversion.
• High free cash flow margins and low capex intensity: Provide flexibility for dividends, buybacks, and debt reduction.
• Pricing power and operating leverage: Preserve margins in a slowing growth environment and maintain earnings quality.
• Conservative balance sheets and low leverage: Limit downside in rising-rate scenarios.
• Reasonable valuations: Discounted FCF yields and normalized EBITDA multiples offer a margin of safety.

The incoming Federal Reserve messaging complicates the picture. Harvey warned that the Fed could issue a “mixed message,” balancing progress on inflation with lingering labor market strength and resilient consumer demand. Such ambiguity can create episodic volatility: hawkish signals tend to weigh on rate-sensitive, long-duration growth stocks, while indications of easing can reignite momentum trades. Investors rotating out of high-risk names often hedge for this two-way tug by favoring companies with stable earnings and shorter duration characteristics.

Market reaction to this guidance has been consistent with a tactical move toward quality and value. Equity flows in recent weeks have favored financials, energy, industrials, and select consumer staples, while passive and active allocations to mega-cap software names have softened. Option markets show elevated put-buying on high-beta technology ETFs, suggesting hedging activity rather than pure directional selling. Fixed income yields have remained a central barometer; modest rises in the 10-year Treasury yield have amplified the appeal of stocks with higher free cash flow yields and lower duration.

Implementation details matter. Portfolio managers told CIBC that execution focuses on staggered trimming selling portions of positions in 5% to 10% increments to avoid market impact and using proceeds to increase exposure to stocks with two- to three-year visibility on revenue and margin stability. Tax-sensitive investors are layering rebalances across taxable and tax-advantaged accounts to manage realized gains. For passive investors, switching between broad-market ETFs to sector-tilt ETFs can accomplish exposure shifts with lower trading costs.

Analysts say the rotation is less an abandonment of technology and more a rebalancing across styles and sectors. Portfolio managers quoted by institutional research desks describe trimming stretched positions and redeploying proceeds into companies with sustainable profit pools. Several sell-side strategists recommend screening for firms with FCF yields in excess of portfolio weighted averages and balance-sheet metrics that include net-debt-to-EBITDA below three times for cyclical exposure.

What Investors Can Do

• Reassess concentration risk by capping position sizes in high-beta holdings and enforcing stop-loss or rebalancing rules.
• Prioritize companies with recurring revenue and free cash flow conversion rates above industry averages.
• Increase exposure to lower-duration equities — firms with nearer-term earnings visibility and less sensitivity to multiple compression.
• Consider complements to equity allocations such as short-duration fixed income, inflation-protected securities, or targeted hedges for big-cap tech exposure.
• Maintain liquidity reserves to capitalize on dislocations if the market’s narrative resets.

Risk management remains essential. Rotating out of risk does not imply moving to cash entirely; it means reallocating to firms that can better withstand profit-cycle oscillations and rate volatility. Investors should also monitor Fed communications closely: quarter-to-quarter guidance on inflation, wage growth, and the path of rate cuts will materially affect which stock traits outperform. Rebalancing frequency should reflect both portfolio objectives and trading costs to avoid incidental tax or execution drag.

Conclusion

Harvey’s checklist for the rotation trade provides a pragmatic framework for investors seeking to lower portfolio volatility without sacrificing long-term return potential. Prioritizing recurring revenue, free cash flow, conservative leverage, and reasonable valuations can reduce downside in choppy markets while preserving participation when growth narratives recover. As the Fed navigates a nuanced policy path, investors who emphasize fundamentals and risk controls are better positioned to weather short-term dislocations and capture value when market leadership rotates back to growth.

Summary: Investors rotated out of high-risk software into quality/value following a February sell-off tied to AI-related valuation reassessments and amid mixed Fed signals.