A market-moving force might be about to hit a stock market that is moving very quickly.
In the past week, U.S. stocks were extra shaky as investors dealt with a sharp drop in big-tech stocks and a shift toward small-cap and value stocks. This change from big to small has been one of the main market trends in July. It’s become so common that it has its own name: the “great rotation.”
The change was going to happen in many ways. NVDA stock went up almost 150% in the first half of 2024, and META stock went up over 42%. Other stocks in the so-called “Magnificent Seven” also had a great start to the year. The rise of these stocks helped the big stock indexes go up, but it also made the market very narrow.
It was time for the pendulum to swing the other way, and the recent drop in tech prices was just that. The prices of Magnificent Seven stocks went back to reality and even went into correction area. This made markets go down too, like the S&P 500 SPX 0.25% and the Nasdaq Composite COMP 0.56%, because they have a lot of technology stocks in them.
As of July 26, when the market closed, the Russell 2000, RUT 0.25%, which tracks small-cap stocks had gained 10.2% over the past 12 trading days. There was a 13.3% difference between it and the S&P 500. This was the biggest difference between it and the S&P 500 in 12 days, according to Dow Jones Market Data. It did better than the Nasdaq Composite by 17.1%, which was its second-largest 12-day showing better than the Nasdaq.
The Russell 2000 had a 3.5% weekly gain on Friday, which was better than the three major stock indexes.
“When I think about how the market got to be so valuable, I do think that this correction over the last week or two has been very healthy,” Dave Sekera, chief U.S. market analyst at Morningstar, told MarketWatch. “It also shows a rotation going on below the surface. We’re seeing a lot of people move out of AI stocks, tech stocks, and large-cap growth stocks and into value stocks and small-caps as their capitalization goes down.
Even though days with big drops can be scary, investors are finding it harder and harder to explain why megacap stocks are worth so much. Alphabet GOOG 1.25% GOOGL 1.27% gave investors a taste of this on Wednesday when it reported better-than-expected earnings, but the stock still fell 5%.
MarketWatch talked to Emily Roland, co-chief investment strategist at John Hancock Investment Management. “I think the challenge is that the earnings weren’t bad, but they had to be amazing to justify the drive up in prices,” she said.
But the July meeting of the Federal Open Market Committee next week could change the direction of this trend.
What to pay attention to at the Fed meeting
The FOMC is set to meet on July 30 and 31. Even though the Fed isn’t likely to lower interest rates at the meeting, investors will be watching to get a better idea of when the Fed might start to do so.
Rate hikes and cuts aren’t always the best way to help the economy, and they have different effects on different parts of the economy. This is especially true for small-cap companies compared to large-cap companies. This is because small businesses need business loans more to stay open and grow.
“Most people think that when rates go down, it’s good for small-cap stocks in two ways,” Thomas Martin, senior portfolio manager at Globalt Investments, told MarketWatch. “Small-cap companies are more affected by variable-rate loans, floating rates, and short-term rates.”
Martin said that when interest rates are lowered, small businesses can get loans for less money. This means that their running costs should go down, which can help their earnings. He also said that lower rates can help the business, which can mean that customers can spend more money.
Investors began switching from megacap stocks to small-cap stocks before the first rate cut of this cycle. This means that when the Fed starts dropping rates, small-cap stocks could gain even more ground. Martin believes that the great shift might be able to go on, at least in part.
That’s right, it’s a recalibration that makes things more fair between the different parts of the market. Martin told MarketWatch, “I think there are a few more to go.” “It doesn’t go any further than the idea that you should see a lot of different places and keep an open mind.” It doesn’t mean you go from being all about growth to being all about worth.
This might have something to do with rate cuts, which can be good and bad at the same time. The economy would probably grow faster if interest rates were lowered, but cutting rates could also mean that the economy needs to grow faster. The Federal Reserve is lowering interest rates. Is it because it beat inflation or because high rates are hurting the economy? People who invest will be very interested in how Powell answers this question.
The person who works for MarketWatch said, “I think the talk we’ll hear is that they are getting more confident that inflation is really going down the path they want it to go down so they can feel comfortable cutting the federal-funds rate.” “I’ll also be paying close attention to what Chair Powell has to say about how strong the economy is and what he thinks the future holds for it.”
It will help the fight against inflation if the Fed says that the economy has been slowing down a bit. But if it slows down too fast, there’s a greater chance of a recession. Because they aren’t as protected from economic downturns as large-cap companies, small-cap companies tend to feel it more when the economy slows down.
Roland at John Hancock told MarketWatch, “We’ve got these little cracks in the job market and these little cracks in the economy, which are enough to — I think — get the Fed to start cutting.” “The Federal Reserve is trying to pull off this amazing soft landing, but it’s going to be very hard.”
Investors are still waiting to see if the economy’s small cracks keep getting bigger and scarier. It could be bad for small-caps if they do. There has been a tightrope walk between the Fed and small-caps as they try to avoid a hard crash. The best thing that could happen is if they get there, but that’s a big “if.”
Wall Street will definitely be listening to the FOMC meeting to hear how the Fed sees the economy and try to guess how likely it is that there will be a soft landing.
Before Monday’s market opened, futures for the big U.S. indexes were going up. The Dow DJIA -0.15% futures were up about 0.5% to around 41,028, the S&P futures were up about 0.6% to around 5,530, and the Nasdaq futures were up about 0.9% to around 19,340.
