Since the bull market began in October 2022, the stock market’s rally has been driven primarily by artificial intelligence and the outperformance of some large-cap stocks, prompting investor concerns that gains may not be widespread enough for the rally to continue.
That may change.
The stock market has been in turmoil in recent days following Thursday’s higher-than-expected inflation numbers, as investors rapidly priced in the increased likelihood of the Federal Reserve cutting interest rates in September, leading to underperformance in some of the most popular sectors over the past year as investors shifted money outside of technology.
The Round Hill Magnificent Seven ETF, which tracks a group of big tech stocks that have driven the stock market’s rally in 2023, is down more than 1.5% over the past five days. Meanwhile, interest-sensitive sectors real estate (XLRE) and financials (XLF) have posted some of the market’s biggest gains over the same period. The Russell 2000 (RUT) index of small-cap stocks has risen more than 7%, surpassing its 2022 high for the first time in the current bull market.
Another sign of the broader gains is that the equal-weighted S&P 500 (^SPXEW), which ranks all stocks in the index equally and is not overly influenced by the size of stock price gains or losses, outperformed the traditional market-cap weighted S&P 500.
Carrie Cox, chief market strategist at Ritholtz Wealth Management, told Yahoo Finance that recent market activity has been “exhilarating” and could be a sign that the bull market is maturing, with a wide range of stocks contributing to the rally and helping to drive stock indexes to all-time highs.
“If this trade continues, and the prospect of a rate cut this fall still holds, then the bulls may finally be waking up, which would be good news for all investors,” Cox said.
This isn’t the first time strategists have been optimistic about a market rotation like the one currently taking place: There were also broad-based rallies in December 2023 and the first quarter of this year.
The question is whether the stock market rally is finally starting to expand significantly, or whether this is another misconception as the market is becoming overly optimistic about the Fed’s rate cuts.
“Our confidence is higher now than it was in December. [during the Fed pivot-driven market rally]Ohsung Kwon, senior equity strategist at Banc of America Securities, told Yahoo Finance.
Kwon noted that the current rally is driven by hopes of a soft landing and gradual interest rate cuts from the Fed, which are little different from previous sharp expansions. But this time, “the earnings environment is really supporting this rotation as well,” he said.
The story continues
According to Bank of America’s earnings analysis, 493 stocks excluding the Big Tech “Magnificent Seven” are expected to see their year-over-year revenue growth during the current reporting period for the first time since 2022. As seen in the chart below from JPMorgan Asset Management’s June interim outlook, revenue growth for these stocks is expected to accelerate in the coming quarters, while Big Tech revenue growth is expected to slow.
Given that earnings are the primary driver of stock prices, this would support the theory that stock price gains will extend. But an important caveat is that these are just estimates. And given that the market has struggled to produce broad winners so far this year, some strategists would like to see actual earnings growth to back up the story that’s now priced into estimates.
“I would love to see earnings growth in more sectors than just tech,” Cox said. “I think that’s the big theme this season, is seeing how many sectors can actually come together and drive up earnings expectations for the S&P 500.”
The same can be said about other theories supporting the recent rotation: Markets are now pricing in a more than 90% chance that the Fed will cut rates in September, according to the CME FedWatch tool. But Cox is cautious about calling the expansion a sure thing.
“Until we officially enter a rate-cutting cycle, it’s hard to say this growing trade is going to continue,” Cox said. “I hope that will happen, I’m optimistic, but the market will still be closely watching the economic data that comes out.”
Kevin Gordon, senior investment strategist at Charles Schwab & Co., is also cautious about declaring big rate hikes have arrived, saying “greater clarity” about the Fed’s rate-cutting cycle and why it’s starting to cut remains paramount, especially for the most interest-rate sensitive parts of the market, such as small-cap stocks.
Gordon argued that the recent market movement is a “big step in the right direction.” But a broad rally won’t happen overnight, he said. “Everybody’s saying this is the great rotation, but great rotations tend to last a little longer than a few days,” he added.
And even if that rotation plays out slowly, recent index performance suggests it could mean a different, more gradual upward path for the S&P 500. The S&P 500 closed lower last Thursday as investors pulled out of large tech stocks, which have a larger weighting in the index than small caps, despite the release of an encouraging inflation report for June.
“We may see a little bit of this disruption with some stocks handing the baton to others,” Cox said. “Tech stocks are handing the baton to others. Sure, prices may not soar as fast as they have in the past, but this is strengthening the foundations of the bull market, which means this rally could end up being even stronger and more durable.”
The Charging Bull bronze sculpture in the Financial District in Manhattan, New York City on October 23, 2022. The sculpture was created by Italian artist Arturo Di Modica in the wake of the Black Monday stock market crash of 1987. (Photo by Beata Zawrzel/NurPhoto via Getty Images) (NurPhoto via Getty Images)
Josh Shaffer is a reporter for Yahoo Finance. Follow him on X Follow.
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