Introduction
Valuation multiples are not just company-specific; they move with sector-wide capital flows that rotate between industries based on economic cycles, policy shifts, technological disruption, and investor sentiment. Understanding these rotation dynamics is essential for interpreting trading comps, evaluating precedent transactions from different periods, and advising clients on M&A timing.
Sector Rotation in Action: The Oil Shock, the AI Split and Peak Defense
Energy: A Rotation Driven by a Supply Shock
Energy entered 2026 out of favor, with Brent near $61 a barrel, and became the market's leader within weeks. After the US-Israeli strikes on Iran on February 28 and the de facto closure of the Strait of Hormuz, Brent passed $100 on March 12 and ended the first quarter at $118, according to the EIA. By early April the S&P 500 energy sector was up about 34% for 2026 as the broader index fell, CNBC reported.
The trade then reversed. A June memorandum of understanding between Washington and Tehran let more tankers through the strait and Brent slid to $72 by July 1, then climbed back above $100 by July 23 once fighting resumed, the EIA's third-quarter review shows. At the start of September energy was again the top S&P 500 sector, up 43% for 2026, while consumer discretionary, where fuel costs squeeze big-ticket retail, was the weakest, per CNBC's sector data. For oil and gas valuation, a supply-shock rotation prices the expected length of the disruption, not a permanent re-rating, so it can unwind as fast as it arrived (see the commodity price environment).
Technology Splits: AI Hardware Climbs, Software Cools
Technology stopped trading as one sector. AI hardware kept rising: NVIDIA set another record in the week to October 10, taking its market value near $6 trillion, CNBC reported. Fears that AI agents would replace seat-based software sent the iShares Expanded Tech-Software ETF (IGV) down 24% in the first quarter, per CNBC, and the SaaS valuation reset spread to private marks. A long-time premium sector was de-rated on a change in its terminal value story, not a collapse in current earnings.
By mid-October the rotation inside tech had flipped, from semiconductors back into software, with IGV up more than 13% over three months while the iShares Semiconductor ETF fell more than 4%, the same CNBC analysis found. AI valuation premiums are set by flows between sub-sectors as much as by fundamentals.
Defense: When Expectations Run Ahead of Earnings
Aerospace and defense was 2025's other hot trade, lifted by NATO's pledge to spend 5% of GDP on defense and security by 2035, and the Iran war looked like a further catalyst. US defense stocks fell instead: the iShares U.S. Aerospace & Defense ETF (ITA), up five years in a row, dropped about 12% from the start of March to late April while the S&P 500 gained 3.5%, CNBC reported. RTX and Lockheed Martin results missed lofty expectations, and investors began asking whether peak defense had arrived despite growing backlogs. When a sector's EV/EBITDA multiples already price in perfection, merely good news becomes a de-rating catalyst.
- Sector Rotation
The migration of capital from one sector to another, driven by the economic cycle, interest rates, policy shifts, or technological disruption. Rotation expands valuation multiples in the sectors receiving capital and compresses them in the sectors losing it, independent of the underlying companies' fundamentals. Rising interest rates, for example, typically move capital from growth sectors (technology, valued on distant cash flows) toward value sectors (financials, energy, valued on current earnings), even if no sector's earnings change.
Why Rotation Matters for Valuation
Comps Are Sector-Cycle-Dependent
Trading comps reflect the current state of the sector rotation cycle, not permanent value. A technology company valued at 20x EV/EBITDA when tech is in favor may trade at 12x when capital rotates away, with its fundamentals unchanged. The analyst must judge whether the comps reflect a sector premium (which may revert) or a sustainable re-rating (which is permanent).
Precedent Transactions Span Different Sector Cycles
A software precedent transaction from 2021, when the sector traded at peak multiples, is a poor guide to a deal priced after the 2026 sell-off, when such assets were marked down on AI-disruption fears. Each precedent must be read against the sector cycle in which it was priced. A deal at 25x EV/EBITDA during a sector's peak phase may overstate what the market will pay now.
M&A Timing Is Sector-Cycle Timing
The most value-creating M&A decisions are often sector-cycle decisions. Selling when your sector's multiples are elevated (at the peak of the rotation into your sector) maximizes the sale price. Buying when the target's sector is out of favor (at the trough of the rotation away from the sector) minimizes the entry price. Simple in concept, this is hard in practice: predicting rotation peaks and troughs is as difficult as timing any market.
