As the Magnificent Seven mega-cap stocks experience heightened volatility, Schwab Asset Management CEO and Chief Investment Officer Omar Aguilar joins Yahoo Finance Live to provide insight into how investors should navigate their portfolios during this period.

Aguilar highlights a notable shift in the mega-cap tech sector, transitioning from being "a momentum trade to a fundamental trade" due to fading AI hype. He emphasizes that for these companies to deliver on future expectations, they will require significant capital expenditure and research and development investments. As expectations for these stocks remain elevated, "investors are questioning" whether the current levels of gains can be sustained over the long term.

With the highly anticipated Consumer Price Index (CPI) data set for release Tuesday, Aguilar advises investors to "expect more volatility." However, he suggests that investors should view this volatility as an opportunity to rebalance their portfolios and strategically position themselves for evolving market conditions.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Angel Smith

Video Transcript

JULIE HYMAN: Meta isn't the only megacap seeing some losses. For more on the recent struggles from the Magnificent Seven, and where investors should look to turn to outside of big tech. We want to welcome in Omar Aguilar, Schwab Asset Management CEO, and CIO.

Omar, thank you so much for being here. So as we see, what looks like a faltering perhaps of the Mag Seven, as well as a broadening of rallies elsewhere in the market, where do you think investors should be looking? Is it either, or is it both, how do you think about it?

OMAR AGUILAR: Well, that's a great question and very timely I think as you were discussing this earlier. The momentum trade has started worldwide when everybody was talking about AI over a year ago. I think that momentum trade started to just be as just a function of excitement, just a function of-- investors getting really excited about the potential.

I think as we go in through this year, this has actually shifted from just being just a momentum trade to be a fundamental trade. And if you actually think so earnings, despite the valuation numbers for these Magnificent Seven, has been significantly better than the rest of the market. So they have outperformed over EPS year-over-year growth of 60%. Whereas the rest of the market has actually been on a decline of EPS growth.

So when you actually put that together with the fact that they also have had very consistent free cash flow yields, you know, that actually provides a lot of the support. Now, that's the past. The future, basically, expectations required a lot of the discussion that you just had, which is a significant amount of ramp up of CapEx and R&D in order for them to support what the market expects they will deliver in the future.

- Omar, is it that the next shoe to drop here? That once these companies report in coming weeks, there's no possible way they can meet up to the expectations that have been priced into their stocks. So that's what investors are doing today selling these positions.

OMAR AGUILAR: Well, I think the investors are looking at the relative valuations. They're basically looking at it. It looks a little bit higher now compared to any other big runs in markets.

They're still not at the level of what we saw in the late '90s or even in the energy boom that we had afterwards. So still in that context, you know, it's really more about the function of the expectations.

Over the next five years is that they will deliver 30% top line growth and 17% on EPS growth, which is very hard to sustain. So investors are questioning whether or not that's actually sustainable. And there are a couple of those seven that are in the process of ramping up that R&D, and that CapEx. That obviously may have a better future going forward.

JULIE HYMAN: Omar, I want to ask about CPI tomorrow, right? Because it has seemed in recent weeks that the focus has shifted a little bit away from the Fed, and to earnings, and to the AI theme. Does CPI tomorrow shift the focus back, or does it just depend on what the number shows?

OMAR AGUILAR: I think, in general, we should expect more volatility. I think once we got past the earnings season, you know, I think the question becomes the CPI reading is really just going to ask, or give us a little more information of what the reaction function by the Fed might be. And it's really just about the timing where they may actually come up with the first rate cut.

And I think investors will continue to look at opportunities to take that volatility, whether it's valuation-driven, or whether it's related to macro to be able to rebalance their portfolio and strategically positioned for the next six months on an environment that will have lower interest rates on the short part of the curve.

- If one is worried about the AI trade fizzling out, Omar, what is the best sector they should be looking at right now and make your case?

OMAR AGUILAR: Yeah, I think what we have encouraged our clients to do is to-- if you think about the economic cycle as we are today, even with the CPI numbers tomorrow, we have all signed that this is the last phase of the cycle. What that means is that soft landing scenario that the Fed has talked to us is basically now being a reality.

And what that means is that the cyclical trade going into the next phase is probably areas that will basically provide good opportunities. And that includes materials, that includes energy, that includes areas that are a little bit more prone to lower interest rates, or at least a shape of the yield curve that is more normal like financials.

So I think we're encouraged clients to start looking at that. And we have seen already small caps are incredibly attractive, and the rest of the market outside of just the large mega caps will probably do well.