After the Rotation From Big Tech, Stocks Sway After Broadening Rallies Appear in Doubt

After experiencing a recent surge, U.S. stocks are now exhibiting instability as investors shift away from the dominant Big Tech shares in the S&P 500 index. This volatility has risen as shareholders have opted to sell off shares of large-cap companies, redirecting their focus toward other sectors within the equities market.

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On Friday, the S&P 500 (SPX) recorded its third consecutive day of decline, marking its lowest closing since early July, as reported by Dow Jones Market Data.

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The transition away from the "Magnificent Seven"—a collective term for major tech firms—toward stocks sensitive to interest rates gained momentum following a cooler-than-anticipated inflation report on July 11, according to a Yardeni Research note from July 18.

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The signs of decreasing inflation have bolstered investor confidence, suggesting that the Federal Reserve might reduce interest rates as early as September. This optimism has led to increased investments in small-cap stocks and various sectors such as financials, real estate, utilities, industrials, and materials, as indicated by Yardeni's analysis.

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For the ongoing bull market in U.S. stocks to expand, additional economic data similar to the recent indicators driving the surge in small-cap stocks is necessary, according to Liz Ann Sonders, chief investment strategist at Charles Schwab. The continuation of the rally likely depends on more reports of mild inflation, which would support the Fed's potential shift to a more lenient monetary policy by September, Sonders noted in a phone interview. However, she cautioned that the recent significant outperformance of small-cap stocks might not be sustained.

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The U.S. stock market ended lower on Friday, with the S&P 500 experiencing its worst week since April, driven by a 5.1% drop in its information-technology sector.

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Nvidia Corp., a leading AI chip maker with a market valuation of approximately $3 trillion, saw its stock fall by about 8.8% over the week. Similarly, the Roundhill Magnificent Seven ETF—which includes Nvidia, Apple, Microsoft, Alphabet (Google's parent company), Amazon, Tesla, and Meta Platforms—recorded a 4.8% decline for the week.

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Yardeni highlighted the Roundhill Magnificent Seven ETF's performance from July 10 to July 18 in a chart, comparing it with other segments of the U.S. stock market, including mid-cap and small-cap equities. During this period, small-cap stocks in the financial sector achieved the most significant gains, while the Magnificent Seven ETF experienced the most substantial losses.

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Scott Wren, senior global market strategist at Wells Fargo Investment Institute, expressed a preference for U.S. large-cap stocks, viewing the recent shift to small-cap stocks as temporary. He stated that they are still underweight on small-caps, anticipating that the economy is heading towards a "soft landing" rather than a recession.

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In the upcoming week, investors will be closely monitoring the U.S. economic growth estimate for the second quarter, which the Bureau of Economic Analysis will release on July 25. Additionally, the personal-consumption-expenditures price index, the Fed's preferred inflation gauge, will be reported on July 26.

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Lindsay Rosner, head of multisector fixed-income investing at Goldman Sachs Asset Management, mentioned that inflation is "normalizing" while the labor market is "cooling." She expressed confidence that the Fed is likely to cut its benchmark interest rate in September.

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Over the past week, U.S. stock-market volatility has increased significantly. The Cboe Volatility Index (VIX) rose to 16.52 on Friday, marking a 32.6% weekly increase—the largest since March 2023. Nonetheless, the VIX remains below its long-term average of around 20.

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Political uncertainty, particularly concerning the U.S. presidential election, may also be contributing to investor anxiety. Stock and bond valuations need to be reassessed considering the potential policies of the election winner. As the weekend approached, speculation continued about whether President Joe Biden would remain the Democratic nominee, although he reaffirmed his commitment to the campaign trail.

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Rosner recommended incorporating bonds into investment portfolios, highlighting the advantage of relatively high yields and the stability they can offer during periods of market volatility.

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Despite recent fluctuations, the S&P 500 has risen 15.4% this year, closing at 5,505 on Friday, which is 2.9% below its record high on July 16. The index has surged 33.7% from its 52-week low on October 27. According to Wren, after such a significant rally, some pullback in gains was inevitable.

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Historically, the stock market experiences a 10% pullback approximately every 10 and a half months, making predictions of such corrections relatively common, Wren explained. The S&P 500 has not seen a 10% decline since its recovery from the October low.

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While both the S&P 500 and the technology-heavy Nasdaq Composite fell last week, the Dow Jones Industrial Average achieved its third consecutive week of gains. The Russell 2000 index, which tracks small-cap U.S. stocks, recorded a 1.7% weekly increase.

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Investors are currently reassessing their positions, with Rosner noting that the narrative of a "soft landing" remains plausible.

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