The bull market in US stocks has been quite volatile over the past few weeks, as the strength appears to be broadening out as investors rotate from large and mega-cap equites and into small/mid capitalised names. The triggering event was a better-than-expected June CPI report on 11 July. Since then, the financial markets have priced in a 90% probability of a Fed rate cut in September.
Investors responded by rotating out of the S&P 500’s Magnificent-7 into the S&P 1493 (i.e., 1500 minus 7). Interest-rate sensitive stock sectors – especially the S&P 400 and S&P 600 Financials, Real Estate, Utilities, Industrials, and Materials sectors – have risen the most.
In the 5 days following the release of the June CPI figures, the Russell 2000 rocketed an amazing 12% even as the Nasdaq Composite barely remained green. It was a surge that had never been surpassed by any of the major US stock indexes. As the Magnificent-7 took a break, smaller pockets of strength filled the leadership void. Real Estate led the large-cap sectors, up 7%. On its heels, cyclicals and values were well represented, as Materials, Industrials, Energy, and Financials were all up about 5%. As they say, sector rotation is the lifeblood of bull markets.
Why are investors rotating out of the mega-cap tech leaders? Because they have had such a magnificent run already. Even though their earnings outlooks are still strong, there are a couple of things happening that are hurting those big technology names that have done so much for the Nasdaq and the S&P 500.
- One nagging thought is that valuations are already stretched, and maybe the optimism from artificial intelligence has become a little overblown. Time will soon tell whether earnings momentum will continue to flow through at their 2Q24 results.
- The prospect of imminent Federal Reserve interest-rate cuts anticipated for September makes the rest of the market more attractive. The Mag-7 doesn’t need help from the Fed, they’re making enough money without the need to borrow, and they have enormous cash cushions, which is why they’ve done well when rates were on the way up. Almost all other corporates could use lower borrowing costs.
- Trump looks on track to win the November election. The trade “divorce” with China could be costly for the tech sector, as nearly every mega-cap tech supply chain runs through either China or Taiwan, or both.
In the meanwhile, US CEOs are becoming more bullish about prospects, which augers well for a continuation of this strong bull market. It is not just high yielding stocks and small stocks that will benefit from sector rotation: bonds and gold could do well too, especially corporate bonds.
Gold prices have climbed to new records, also on the back of expectations for lower rates. The precious metal can be attractive as a safe haven investment in a downturn, but it can also go up when the relative returns of other assets go down. Prospects for lower rates have also pushed down the dollar since the start of the month. That tends to boost gold and other commodities, priced in dollars, by making it cheaper for overseas buyers.
The Great Rotation won’t be confined to just stocks. Investors have other opportunities to look for more growth.
Source: Apollo
