The ‘Magnificent Seven’ Are Out; These Stocks Are in but There’s One Catch

The U.S. stock market is currently in a transitional phase, with large-cap growth stocks losing their dominance while new sectors compete for leadership. Relative Rotation Graphs (RRG) provide a clear illustration of these shifts, tracking the performance of different sectors through four stages: leading, weakening, lagging, and improving. This cyclical movement highlights how leadership changes over time within the market.

‍

An analysis of RRG charts reveals that growth sectors—primarily technology, communication services, and consumer discretionary—are beginning to weaken. These areas, led by major players like Amazon and Tesla, are still in the leading quadrant but are expected to move into the weakening category if the usual rotation pattern holds. This suggests that the once-dominant growth sectors may soon lose their momentum.

‍

Emerging contenders for market leadership include value-oriented sectors such as financials, industrials, energy, and materials, along with defensive sectors like healthcare, consumer staples, utilities, and real estate. If value stocks take the lead, it could indicate a smooth, bullish rotation within the market. However, if defensive sectors become dominant, it may signal a broader market downturn or correction.

‍

A closer look at sector performance shows mixed signals. Among the growth sectors, only communication services have displayed consistent relative strength. Technology and consumer discretionary sectors, despite their large market presence, exhibit volatile and inconsistent performance. This trend is also reflected in the Nasdaq-100, a benchmark for growth stocks.

‍

Although the Nasdaq-100 recently reached all-time highs, the relative strength of its biggest components—the "Magnificent Seven" stocks—has weakened, further supporting the notion that large-cap growth leadership is fading.

‍

The value sectors, despite being potential new leaders, are not demonstrating strong leadership qualities across the board. Financial stocks have shown some strength, likely due to expectations of regulatory changes that could benefit banks. However, other value sectors display choppy performance, with materials stocks hinting at a possible bottom but lacking a definitive upward trend.

‍

Defensive sectors are also showing signs of stabilizing after a period of weakness, but they have yet to establish themselves as clear market leaders. This suggests that while investors may be turning to these safer sectors, there is not yet overwhelming evidence that the market is preparing for a sustained downturn.

‍

One significant challenge for the market is declining liquidity within the banking system. Historically, stock prices have moved in tandem with liquidity levels. However, while the S&P 500 has continued to climb, liquidity has remained flat for several months.

‍

This divergence raises concerns that a lack of liquidity could eventually weigh on equity markets. Bitcoin, often viewed as a real-time indicator of market liquidity, has also shown a negative divergence from stock prices in recent weeks, reinforcing these liquidity concerns.

‍

Another potential risk factor lies in the currency markets, specifically the yen carry trade. Last August, an unwinding of the yen carry trade triggered a sudden shift to risk-off sentiment, leading to market volatility. With Japanese government bond yields rising due to the Bank of Japan's more hawkish stance, the yen is under upward pressure. If the dollar-yen exchange rate falls decisively below the key 150 level, it could trigger another round of risk aversion and market instability.

‍

Looking ahead, the S&P 500 recently achieved a marginal breakout to a new all-time high, driven by the strength of the Nasdaq-100. However, both indices have since pulled back and are now testing their respective 50-day moving averages—a critical technical level.

‍

Notably, the equal-weight S&P 500 failed to break out, while mid-cap and small-cap indexes, such as the S&P MidCap 400 and the Russell 2000, remain below their 50-day averages. If the S&P 500 continues to weaken, it may target a price gap that begins just below the 5,900 level.

‍

Despite these technical signals, the market remains at levels seen earlier in the year, suggesting that political factors, such as the so-called "Trump Put," could come into play if stock prices decline significantly. This refers to the expectation that the current administration may take action to support markets if they fall sharply.

‍

In the near term, two key events could drive market volatility: Nvidia's upcoming earnings report and an expected decision on delayed 25% tariffs on Canadian and Mexican imports. While investors seem to be downplaying the tariff threat, viewing it as political posturing rather than a serious policy shift, any surprise developments could disrupt market stability.

‍

In summary, the U.S. stock market is at a crossroads, with no clear sector leading the way. The rotation from growth to value stocks is underway but remains incomplete, while defensive sectors are beginning to show strength without fully asserting dominance.

‍

Several external risks—such as declining liquidity, the potential for another yen carry-trade unwind, and renewed trade tensions—add to the uncertainty. Given these factors, a minor correction appears more likely than a sustained bull run, and investors should remain cautious in the current environment.

‍