Tech Mega-Caps Propel Market Rebound Amid Small-Cap Rotation
Tech mega-caps led stocks higher on Monday, rebounding from last week’s sell-off. This movement is part of a significant rotation out of big tech into small caps, triggered by a soft June inflation report. This report raised hopes that the Federal Reserve might cut interest rates in September, providing relief to rate-sensitive small caps.
Market Dynamics: Big Tech vs. Small Caps
The “Magnificent Seven,” consisting of major tech players, is forecasted to report slower—though still impressive double-digit—earnings growth for the most recent quarter. In contrast, small caps are expected to report a decline in profits. Despite this, the Magnificent Seven saw a surge on Monday, ahead of a slew of earnings reports that could influence the ongoing small-cap rotation that had previously affected the market’s leading stocks.
Shares of Nvidia (NVDA) and Tesla (TSLA) each rose by around 5%, while Meta (META) and Alphabet (GOOGL) advanced by more than 2%.
The Small-Cap Rotation Phenomenon
In recent weeks, equity markets have experienced a significant shift due to changing expectations for U.S. monetary policy. For the week ending July 17, the small-cap Russell 2000 outperformed the tech-heavy Nasdaq 100 by over 13.4 percentage points, marking the Russell’s largest seven-day outperformance since 2001 and the third-largest on record.
Optimism regarding a potential Federal Reserve rate cut grew earlier this month when data showed inflation had fallen more than expected to 3% in June. Market participants now see a greater than 90% chance that the Fed will lower its benchmark federal funds rate by 25 basis points in September, according to trading data.
Lower interest rates are particularly beneficial for smaller companies, which are more dependent on floating-rate debt compared to their mega-cap peers.
The Impact of Earnings Reports
The rotation from mega-caps to small-caps could be tested by upcoming earnings reports. Alphabet and Tesla are scheduled to report their quarterly results on Tuesday afternoon, while Microsoft (MSFT), Meta, Apple (AAPL), and Amazon (AMZN) will report next week.
Bank of America Securities analysts expect tech giants to report their second consecutive quarter of slowing earnings growth. Profits are forecasted to have increased by 30% from the previous year, compared to 53% in the prior quarter and 63% in the quarter before that.
Meanwhile, the rest of the S&P 500, often referred to as the “Other 493,” is expected to report earnings growth for the first time since 2022. Profit growth has been stagnant for much of corporate America over the past year and a half due to a slowing economy and higher interest rates.
Outlook for Small Caps
The outlook for small caps remains uncertain. Initially, Bank of America analysts forecasted the Russell 2000 would grow earnings by 16% for the most recent quarter. However, they now anticipate a 3% decline in profits. Among the companies that have already reported, small caps have missed earnings and sales estimates more frequently than large caps.
Analysts suggest that if small-cap companies fail to show improvement, the recent outperformance may pause. However, better guidance and revisions could continue to drive the rally in small caps.
Conclusion: Navigating the Market Shift
The tech mega-caps have shown resilience, propelling the market higher despite recent volatility and a shift towards small caps. As earnings season progresses, the performance and guidance from both mega-caps and small caps will be crucial in determining the market’s direction. Investors will closely watch for any signs of sustained growth or further adjustments in expectations.
Key Takeaways for Investors
- Tech Mega-Caps: Despite recent sell-offs, tech giants are showing strong resilience and are expected to report impressive earnings growth, albeit slower than previous quarters.
- Small-Cap Rotation: The shift towards small caps is influenced by expectations of a Federal Reserve rate cut, benefiting smaller companies reliant on floating-rate debt.
- Earnings Reports: Upcoming earnings reports from major tech companies will be pivotal in shaping market dynamics and investor sentiment.
- Market Outlook: Analysts suggest that better-than-expected guidance and revisions could continue to support the rally in small caps, while lack of improvement might pause their recent outperformance.
Investors should stay tuned to earnings announcements and Federal Reserve policy decisions, as these will significantly impact market trends and investment strategies in the coming weeks.