Since the bull market began in October 2022, the rally in stocks has been largely about AI and the outperformance of a few large stocks, fueling investor concern that gains are not widespread enough to sustain the rally.
This may change.
Thursday’s better-than-expected inflation reading has sent the stock market into a tailspin in recent trading days. As investors have quickly priced in higher chances of an interest rate cut by the Federal Reserve in September, the market’s favorite areas of the past year have underperformed as investors pivot to sectors outside of technology.
The Roundhill Magnificent Seven ETF, which tracks the group of big tech stocks that led the stock market’s 2023 rally, is down more than 1.5% in the past five days. Meanwhile, Real Estate (XLRE) and Financials (XLF), both interest rate-sensitive sectors, have been the market’s biggest gainers over the same time period. The small-cap Russell 2000 Index ( RUT ) is up more than 7% and finally surpassed its 2022 high for the first time during the current bull market.
In another sign that a broad swath of stocks are rising, the equal-weight S&P 500 (^SPXEW), which ranks all stocks in the index equally and isn’t affected much by the size of stocks that move up or down down, has exceeded performance. Traditional market cap weighted S&P 500.
Ritholtz Wealth Management chief market strategist Callie Cox told Yahoo Finance that the market action of late has been “refreshing” and could be a sign of a bullish market where a wide range of stocks are contributing to the rally. providing more support for the stock. indices at record levels.
“If this trade continues, if the prospect of a rate cut is still in play for this fall, then we may finally see the bull wake up and that’s good news for all investors,” Cox said.
It is not the first time that strategists have been optimistic about market rotations like the one currently taking place. Other outbreaks of widespread rallies were celebrated in December 2023 and during the first quarter of this year.
The question is whether a big expansion in stock market gains is finally underway this time, or if this is another bogus one as the market becomes overly optimistic about the Fed’s rate cuts.
“The level of conviction we have is higher now than it was in December [during the Fed pivot-driven market rally],” Ohsung Kwon, senior equity strategist at Bank of America Securities, told Yahoo Finance.
Kwon notes that the narrative driving growth — hopes for a soft and gradual rate cut by the Fed — is largely unchanged from earlier expansionary growth. But this time, he said, “the revenue background is really supporting this rotation.”
Bank of America’s earnings analysis shows that 493 stocks, not including Big Tech’s “Magnificent Seven,” are expected to increase year-over-year earnings for the first time since 2022 during the current reporting period. As seen in the chart below from JPMorgan Asset Management’s June outlook, these stocks’ earnings growth is expected to pick up in the coming quarters, while Big Tech is expected to see its earnings growth slow.
Given that earnings are usually the main driver of stock prices, this would support the theory of an upward trend. But the main caveat is that these are just expectations. And given the market’s struggle so far this year to produce a broad range of winners, some strategists want to see actual earnings rise to confirm the narrative currently seen in valuations.
“I want to see earnings growth come from more sectors than just technology,” Cox said. “I think that’s the big theme of this particular season. You know, seeing how many sectors can actually come in and drive S&P 500 earnings expectations higher.”
The same can be said for the other narrative supporting the latest rotation. Markets are now pricing in a more than 90% chance the Fed will cut interest rates in September, according to the CME FedWatch tool. But again, Cox is careful to say that the expansion will certainly continue.
“Until we’re officially in that rate cut cycle, it’s hard to say that this expanding trade is here to stay,” Cox said. “I hope it is. I’m optimistic that it is, but you’re still going to have a market that depends on every piece of economic data that comes out on tape.”
Charles Schwab chief investment strategist Kevin Gordon is also careful to state that the big expansion is coming. Gordon noted “more clarity” on the Fed’s tapering cycle and why it would begin tapering remains paramount, especially for the most interest-rate-sensitive areas of the market such as small caps.
Gordon reasoned that the market’s recent action has been a “big step in the right direction.” But a broad rally won’t come overnight, Gordon said. He added, “The nature has been for everyone to say it’s this big spin, but big spins tend to last a little more than a few days.”
And even if that rotation happens slowly, the index’s recent performance suggests it could mean a different, slower path higher for the S&P 500 as well. The S&P 500 closed last Thursday despite the release of a promising inflation report in June, as investors moved away from large technology stocks, which carry more weight in the index than smaller stocks.
“We may see a little bit of this trickle down where some stocks are passing the baton to other stocks,” Cox said. “Tech stocks are passing the baton to other stocks. Sure, we may not see prices rise as quickly as they have. But that’s the kind of move that strengthens the foundation of a bull. That means this rally could be stronger and live longer eventually.”
Josh Schafer is a reporter for Yahoo Finance. Follow him to X @_joshschafer.
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