The stock market experienced a dramatic transformation in July, with a clear shift away from the technology sector that had been instrumental in driving market gains during the first half of the year. Instead, small-cap stocks surged, fueled by shifting expectations around interest rates and changing economic indicators. This inversion of trends marked a pivotal moment in the market, highlighting the evolving landscape of sector performance and investor sentiment.
Tech Stocks Falter as Small-Caps Surge
In July, technology stocks, which had been key drivers of market growth earlier in the year, stumbled significantly. The Information Technology sector saw a decline of 2.1%, while Communication Services, heavily influenced by technological advancements, fell by 4.2%. This drop was in stark contrast to the strong performance of tech stocks in the earlier part of the year, which had been buoyed by robust earnings reports and technological innovations.
Conversely, small-cap stocks experienced a remarkable turnaround. The Russell 2000 Index, which tracks smaller companies, surged by 11.5% in July, marking its most substantial rally since the upheaval of the COVID-19 pandemic in 2020. This resurgence was driven by growing expectations that the Federal Reserve might begin to cut interest rates as early as September, providing a much-needed boost to sectors that are more sensitive to interest rate fluctuations.
Sector Performance: Real Estate and Financials Lead the Way
July’s market performance was characterized by unexpected leaders. Real Estate, which had been one of the worst-performing sectors over the past year, surged by 7.1%. Similarly, Financials saw a robust gain of 6.3%. This turnaround was largely driven by investor optimism about potential interest rate cuts, which are expected to benefit rate-sensitive industries.
The pivotal moment came on July 11, when data showed an unexpected decline in consumer prices for June. This inflation report strengthened Wall Street’s belief that the Federal Reserve might initiate interest rate cuts soon. As a result, sectors that had been hit hard by previous rate hikes, such as regional banks and homebuilders, saw significant gains. Regional bank stocks rose by 18.5%, while homebuilder stocks increased by 17.6%, as investors anticipated that lower rates could revitalize the lagging U.S. housing market.
Divergence Between Big Tech and Small Caps
July also highlighted a significant divergence in performance between big tech stocks and small-cap equities. The “Magnificent Seven”—a group of major technology companies including Apple, Microsoft, and Nvidia—experienced a decline of 2.7%. This decrease in tech stock performance contrasted sharply with the Russell 2000’s impressive gains, creating a 14.2 percentage point gap between the two groups. This gap represents the largest divergence in performance data going back to 2015, underscoring the dramatic shift in market dynamics.
Outlook for August: Will the Trend Continue?
Looking forward to August, a key question is whether the rotation from tech stocks to small-caps will persist. Technical analysts are optimistic about the potential for continued small-cap strength. Bank of America’s Stephen Suttmeier noted that the Russell 2000’s rally was accompanied by an increase in the number of small-cap stocks reaching 52-week highs and a rise in trading volume. These factors suggest a “big base breakout,” indicating a potentially sustained upward trend for small-cap stocks.
Additionally, macroeconomic conditions appear to be aligning favorably for small caps. Recent data releases, including a positive second-quarter GDP report and mixed signals from durable goods reports, suggest that while the economy is cooling, it is not on the verge of a severe downturn. Quincy Krosby, Chief Global Strategist at LPL Financial, highlighted that this balanced economic environment could continue to support the rotation into small-cap stocks.
Risks and Considerations
Despite the positive outlook, investing in small-cap stocks comes with inherent risks. Small caps are known for their volatility and can experience rapid sell-offs in response to significant changes in market direction. The current economic and political uncertainties add to the complexity of navigating the small-cap market.
Investors should remain cautious and consider the broader context of economic indicators and potential risks. The evolving landscape of interest rates, economic data, and sector performance will continue to influence market dynamics as we move through the remainder of the year.
In summary, July’s market performance marked a notable shift from tech dominance to a resurgence in small-cap stocks. As expectations for interest rate cuts drive market behavior, investors will need to stay vigilant and adaptable to the changing economic landscape and potential risks.