A New Leg Up for the S&P 500 Hinges on Battered Stocks Getting Revenge

Segments of the stock market outside Big Tech are surging as traders grow increasingly optimistic about imminent interest-rate cuts, fueling hopes for another phase of the bull run.

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An equal-weighted version of the S&P 500, which eliminates market-cap bias, has just experienced its best two-week performance relative to the S&P 500 since November 2020. This shift is notable for the equal-weighted index, which has lagged behind the benchmark for months. This rally is driven by investor optimism over potential monetary easing, pushing them away from the perceived safety of Big Tech.

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Todd Sohn, managing director of ETF and technical strategy at Strategas Securities, stated, “This is all about the bench of the stock market finally stepping up. While all of the best players from Nvidia to Microsoft pause their rally, the rest of the team is holding up their end of the bargain, with the most neglected groups catching a bid.”

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With the S&P 500 Index and Nasdaq 100 Index posting their worst weeks since April, investors are now questioning whether the performance in previously underperforming groups will continue and how stocks will react when the Federal Reserve eventually cuts rates.

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The S&P 500 has been on an upward trajectory for months, advancing in 28 out of 38 weeks since its near-term low in late October. Fund managers are starting to increase their exposure in sectors beyond technology megacaps. Small-cap stocks saw their second-largest inflow ever, with $9.9 billion flowing in during the week through Wednesday, according to data from EPFR Global and Bank of America.

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Jim Paulsen, a well-known stock strategist who correctly predicted this month’s rebound in previously overlooked market segments, believes companies outside of tech will drive the next phase of the bull market. “It’s a rare feat historically to have what many people perceive as a bubble being deflated without igniting a much larger selloff,” Paulsen said. “The crucial question is whether there can be a pullback in big-tech stocks that slightly reduces their hefty concentration without having a massive rout more broadly.”

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While the continuation of this trend is uncertain, some technical indicators are showing signs of being overstretched. Last week, the S&P 500 traded 15% higher than its 200-day moving average. Historically, such a gap preceded losses for the index in 2011, 2015, and 2018, according to data compiled by Andrew Thrasher, technical analyst and portfolio manager at Financial Enhancement Group.

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The S&P 500 just exited what is historically its best two-week stretch of the year in the first half of July and is now approaching its most challenging period in August and September. Upcoming potential catalysts include the start of tech earnings later this month, the U.S. government’s first reading on second-quarter gross domestic product (GDP) due Thursday, and the Federal Reserve’s preferred measure of inflation on Friday. These events may provide insights into the rate outlook and, ultimately, the direction of stocks.

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The consensus expectation is that economic growth will remain strong, with the Atlanta Fed’s GDPNow model projecting second-quarter real GDP growth to climb to a 2.7% annual rate, up from a 1.4% pace in the first quarter.

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Julie Biel, a portfolio manager at Kayne Anderson Rudnick, stated, “Investors won’t tolerate owning companies that struggle with profit growth for more than a quarter. But whenever there’s any whiff of a change in rotation, money managers chase it because it profoundly benefits their portfolio performance — if they catch it early.”

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As the broader market shows resilience, the focus is on sectors beyond Big Tech. The recent performance of small caps and other neglected groups underscores a broader market participation. However, the market's future trajectory is closely tied to economic indicators and the Federal Reserve's decisions on interest rates. Investors are cautiously optimistic but remain vigilant about potential market volatility, particularly with upcoming economic data releases.

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The shift from Big Tech to other sectors represents a significant change in market dynamics. While tech giants like Nvidia and Microsoft have paused their rallies, other sectors are stepping up. This diversification could provide a more balanced market environment, reducing the overreliance on a few large-cap tech stocks. However, the sustainability of this trend will depend on continued economic strength and favorable monetary policies.

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In summary, the recent surge in non-tech sectors indicates a broader market rally driven by optimism over potential interest-rate cuts. As investors shift their focus, the market is experiencing a more balanced performance across various sectors. The upcoming economic data and Federal Reserve decisions will be crucial in determining whether this trend continues. Investors are preparing for potential volatility but remain hopeful for sustained market growth.

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