Thursday was a turbulent day for hedge funds that had banked on the sustained performance of megacap tech stocks while betting against other market segments. This volatility was triggered by a cooler-than-expected June consumer-price index reading, which appeared to prompt a significant rotation into previously neglected sectors. Jay Hatfield, CEO of Infrastructure Capital Advisers, remarked in a phone interview that this shift caused considerable distress for hedge funds that had adopted popular strategies centered on long positions in large-cap tech stocks and short positions in small- and mid-cap stocks.
The market reaction was dramatic. The Russell 2000, representing small-cap stocks, surged by 3.6%, while the tech-heavy Nasdaq Composite slumped by 2%. According to Dow Jones Market Data, this marked the largest single-day outperformance for the Russell over the Nasdaq since records began in 1986. This shift in market dynamics raises an important question for investors: Is this rotation a temporary phenomenon following a period of concentrated market leadership, or is it the start of a broader rally that could extend to other market segments?
Bob Elliott, chief investment officer at Unlimited Funds, noted that baskets tracking the market’s most heavily shorted stocks rose sharply, indicating a squeeze that could persist for some time. On the same day, the S&P 500 pulled back by 0.9% after hitting a record intraday high earlier in the session. In contrast, the more cyclically oriented Dow Jones Industrial Average, which had lagged behind its tech-heavy peers in 2024, managed to hold its ground, finishing with a modest gain of 0.1%.
The moves came after the consumer-price index fell by 0.1% in June, slowing the year-over-year rate to 3%. The core rate, which excludes volatile energy and food costs, rose by just 0.1%, bringing the year-over-year rate to 3.3%, down from 3.4%. While economists suggest that more data will be needed to ensure a rate cut by the Federal Reserve in September, fed-funds futures traders now see a better than 90% probability of at least a quarter-point reduction, according to the CME FedWatch Tool.
The “Magnificent Seven” cohort of megacap tech stocks, which had led the rally since the lows of October 2022 on surging enthusiasm over artificial intelligence, took a beating. Each of these stocks was down by at least 2% as of midday Thursday, translating into a market cap drop of more than $500 billion. This was the largest single-day wipeout since a $557 billion drop on September 13, 2022, according to Dow Jones Market Data.
This sharp decline in heavyweight tech stocks had a significant impact on the S&P 500, even though approximately 80% of the stocks in the index were up for the day. The equal-weighted version of the S&P 500, which gives all components the same weight rather than weighting them by market cap, outperformed its traditional market-cap-weighted sibling by around 1.8 percentage points. This left the gauge of the average S&P 500 stock on track for its biggest relative gain since January 2021. Year-to-date, the equal-weighted S&P 500 had rallied by 4.6%, compared to the cap-weighted S&P 500’s gain of more than 17%.
Jay Hatfield, who also manages the InfraCap Small Cap Income exchange-traded fund, has been anticipating a broadening of the rally and sees potential for it to continue. He expects that as the market prepares for a series of cooling inflation readings, the Federal Reserve will begin to cut rates, an action he believes is overdue given previous signs of cooling inflation and a slowing economy. While he would not go short on tech stocks, he is optimistic about a broader rally continuing, albeit with some volatility. Hatfield has recently raised his year-end target for the S&P 500 to 6,000.
Hatfield also noted that a September rate cut by the Fed would likely be part of a wave of cuts by major central banks, leading to a significant injection of liquidity into the global banking system. Historically, such an increase in liquidity has resulted in rallies for both stocks and bonds.
Sonu Varghese, a global macroeconomic strategist at Carson Group, pointed out that the S&P 500’s pullback on Thursday seemed more extreme due to the selloff in tech shares, but he does not believe this will be a lasting weight on the index. Even if tech stocks consolidate from their current levels, he anticipates that the remaining 493 stocks in the S&P 500, particularly on the large-cap value side, could rally and continue to carry the index forward. This perspective underscores the potential for a broader market rally that could sustain the S&P 500’s upward trajectory despite the challenges faced by the tech sector.