In recent days, the U.S. stock market has suddenly reversed, the laggards in the market have suddenly become active, and the seemingly indestructible "Big Seven" have suffered setbacks.
Right now, investors are paying more attention than ever to corporate earnings as they try to predict what will happen next.
The small-cap Russell 2000 index (RUT) outperformed the S&P 500 (SPX) in the seven days through Wednesday, the biggest gain in that time frame since records began in 1986, according to Dow Jones Market Data. Meanwhile, the Russell 1000 index (RUI) outperformed its growth-stock peers, the most since April 2001, when the dot-com bubble burst.
Few investors saw the shift coming, and many are confused about what’s behind it: Is it a shift in expectations for Federal Reserve rate cuts? Expectations that Trump will return to the White House? Or is it that tech deals are becoming too crowded?
Adding to market uncertainty, U.S. President Joe Biden announced on Sunday that he would not seek re-election.
Now, investors are scrambling to determine whether the reordering of winners and losers is just a blip in the tech-stock era or a sustainable shift is underway.
“That’s the question everyone is trying to answer,” said Raheel Siddiqui, senior investment strategist at Neuberger Berman.
The small-cap index rose 1.7% last week, extending its 2024 gains to 7.8%, while the S&P 500 fell 2%, trimming its year-to-date gains to 15%.
As the Federal Reserve continues to raise interest rates through 2023 to curb inflation and has kept rates high so far this year, investors have rushed into stocks of large companies for a "safe haven" they believe can withstand economic uncertainty and some of which are well positioned to take advantage of the transformative advances that artificial intelligence could bring.
At the same time, traders are cautious about stocks of smaller, more cyclical companies, which tend to be particularly vulnerable to higher financing costs and the risk that Federal Reserve rate hikes push the economy into a recession.
The trade seemed unstoppable early on. Then, on July 11, a surprisingly benign inflation report seemed to change everything. While investors had long expected the Fed to start cutting interest rates, the data made them all but certain that the cuts would begin in September. As markets grew more convinced that rate cuts were coming, investors scrambled to pare back their bets on the technology sector and move into parts of the market that could rebound if rate cuts lowered borrowing costs and boosted the economy.
“Who will benefit when interest rates go down? The answer is the stocks that fell a lot when interest rates went up, the weaker companies,” Siddiqui said.
When the Fed began raising interest rates in March 2022, the 10-year Treasury yield was about 2.2%. In the following months, as the Fed raised interest rates, Treasury yields rose. In October 2023, the 10-year Treasury yield broke through 5% for the first time, setting a 16-year high.
U.S. Treasury yields subsequently fell as investors began to anticipate rate cuts from the Federal Reserve, but they remain high as inflation remains stubborn in 2024.
Another factor at play in the market: growing expectations that Trump will return to the White House after the November election, which could increase the likelihood of tax cuts and deregulation.
For the rotation in market leadership to continue, many believe results and forecasts from individual companies need to reinforce the view that smaller, more cyclical businesses are about to outperform.
Investors this week will be watching earnings reports from Google parent Alphabet (GOOGL) and electric car maker Tesla (TSLA), as well as from nearly 300 smaller companies in the Russell 2000. Next week, Microsoft (MSFT), Meta Platforms (META), Apple (AAPL) and Amazon (AMZN) will report, providing investors with more insights into the big tech companies.
It's not just the excitement that's driving the rush into tech stocks; these companies also dominate huge markets, insulating them from economic fluctuations.
According to data from Ryan Grabinski, investment strategist at Strategas, the "Big Seven" saw profits rise 52% in the first quarter of this year, while profits fell 8.7% for the remaining 493 companies in the S&P 500. Analysts expect profits for the seven companies to rise 28% in the second quarter, while profits for the rest of the S&P 500 will fall 1%.
“Earnings growth will be the key factor in determining whether this trend continues,” said Sumali Sanyal, senior portfolio manager of systematic global equities at Xponance.
Smaller companies tend to be more vulnerable to higher interest rates than larger ones. Companies in the Russell 2000 index have 30% of their debt in floating-rate debt, compared with just 6% for S&P 500 companies, according to research from Goldman Sachs earlier this year.
The Russell 2000 rose just 1% in the first half of this year as investors have lost interest in smaller companies as the Federal Reserve has kept interest rates high.
On the other hand, the biggest stocks have driven the S&P 500's gains. Just one company, chipmaker Nvidia (NVDA), contributed 30% of the S&P 500's 15% total return in the first half of the year, according to S&P Dow Jones Indices. Add in Microsoft, Amazon, Meta Platforms, Alphabet and Apple, and they account for more than half of the index's return.
However, the small number of stocks driving the S&P 500's current rally has worried investors, who are questioning the sustainability of the gains. Nancy Curtin, chief investment officer at AlTi Tiedemann Global, said:
“It’s definitely risky, but I’m happy to see this rotation, it creates a healthier market, a more stable market and frankly gives the bull market more fuel to move higher.”
Article forwarded from: Jinshi Data
