(Bloomberg) – A weeklong decline in megacap technology stocks broadened Thursday to encompass smaller firms and financial shares as signs of economic weakness overwhelmed optimism over rate cuts.
Almost every major group in the S&P 500 fell, with the U.S. equity benchmark down almost 1%. A rally that drove the gauge to almost 40 record highs this year spurred expectations of a pullback or at least consolidation. And those calls have grown after a wide array of companies soared in just a few days, outperforming the leaders of the bull market — the cohort of big techs.
Conviction the central bank is poised to ease back on its battle to subdue inflation has prompted a retreat from megacap stocks, which emerged during the Federal Reserve’s tightening cycle as a de-facto safety trade due to their steady profits and pristine balance sheets. In turn, money recently flowed to a broader swath of industrial and staples firms for whom high financing costs posed a bigger impediment.
While every data point signaling the Fed is a step closer to cutting rates would bolster that trade, it wasn’t the case on Thursday. Wall Street’s “rotation” took a breather even after a surge in jobless claims showed the U.S. labor market continued to cool.
“Investors have quickly moved from ‘over-crowded’ megacap leaders and put money to work in “down-cap” opportunities,” said Craig Johnson at Piper Sandler. “While this makes the case for a broadening bull market, prudence favors pullbacks at confirmed support levels amid improved breadth signals.”
The S&P 500 fell to around 5,545. Megacaps were mixed, with Nvidia Corp. up and Apple Inc. down. The Russell 2000 of smaller firms dropped about 2% after recently hitting its most-overbought level since 2017. The Dow Jones Industrial Average halted a six-day winning streak.
In late hours, Netflix Inc. said it added 8.05 million customers in the second quarter, crushing forecasts. U.S.-traded shares of Taiwan Semiconductor Manufacturing Co. closed with a small gain despite a bullish outlook. Domino’s Pizza Inc. fell the most since 2008 after it unexpectedly suspended its store growth target. D.R. Horton Inc. hit a record high on sollid results.
Treasury 10-year yields rose four basis points to 4.20%. The euro dropped on bets the European Central Bank will cut rates in September.
In just a few days, the Russell 2000 rose more than 10%, with most of the rally coming after Thursday’s cooler inflation data bolstered bets on rate cuts.
Small caps notched their best performance over their larger peers in a five-day period ever, Jim Bianco, founder of his namesake research firm, said in a recent X post. He tracked the difference between the Russell 2000 and Russell 1000 since 1978.
To Dan Wantrobski at Janney Montgomery Scott, the recent “rotation” pushed the broader markets into some moderately overbought territory on a short-term basis. This alongside ongoing extended conditions in leadership areas renders them vulnerable to potential consolidation over the short run, he noted.
“As pundits start to jump on the ‘rotation is real’ bandwagon, we are cognizant of the threat of potential bull traps ahead,” Wantrobski said. “As we noted last week when the change in trend first began, this rotation is in its very early stages, and cannot yet be confirmed as a longer-term investment theme in our opinion. So while we are encouraged by the broadening out of U.S. equity markets most recently, we want to be mindful of any false signals.”
“Certainly, some digestion of the rotation is required after the massive moves of the past trading week,” said Tom Essaye at the Sevens Report. “But whether the rotation can continue will be determined by economic data and earnings.”
While the rotation could continue for weeks as economic data remains mostly “Goldilocks” and tech is still “over owned,” Essaye is not in favor of aggressive allocations to cyclicals for anything other than tactical capital.
“I do remain concerned about economic growth,” he said. “While the market is convinced lower rates will prevent a slowdown, corporate earnings and Fed commentary continue to imply investors are too complacent when it comes to slowdown risks,” Essaye said.
“As the Fed embarks on a rate cutting cycle, markets tend to cheer it initially and even for a short period after the cuts begin,” said Liz Young Thomas at SoFi. “But if that cutting cycle occurs in concert with slowing economic data, disappointing earnings, or a quick compression in multiples, small-caps would likely lose steam quickly.”
That’s not to mention, the Fed typically cuts rates late in the economic cycle, not early in the cycle when small-caps tend to have their moment in the spotlight, she noted.
“In the near-term, this rotation into smalls can continue. Markets are looking forward to easier monetary conditions, and they’re likely to get them this fall. The question is whether that will be followed by a slow and steady cooling in inflation and jobs, or a quick and painful one,” she concluded.
Corporate Highlights:
· SunPower Corp. plunged after the solar company told dealers it would no longer support new installations and was halting shipments.
· PNC Financial Services Group Inc., U.S. Bancorp and Citizens Financial Group Inc. are selling bonds on Thursday, joining the biggest Wall Street banks in tapping the investment-grade debt market after reporting quarterly earnings.
· Apple Inc. is having discussions about licensing more films from major Hollywood studios as it looks to bolster its Apple TV+ streaming service, people familiar with the matter said.
· U.S. shoppers spent US$14.2 billion online during Amazon.com Inc.’s 48-hour Prime Day sale, up 11% from a year ago and in line with estimates, according to Adobe Inc.
· Warner Bros. Discovery Inc. during Amazon.com ring separating its streaming and studio businesses from legacy TV, one of several options intended to boost its share price, the Financial Times reported.
· Infosys Ltd. raised its sales forecast for the year in a sign that clients are gradually beginning to boost technology spending, encouraged by a resilient global economy.
· Ford Motor Co. will invest $3 billion to build its highly profitable Super Duty F-Series pickup truck at a plant in Ontario, Canada, shifting focus at the site after previously delaying plans for electric sport utility vehicle.
Key events this week:
· Japan CPI
· Fed’s John Williams, Raphael Bostic speak, Friday
· Canada retail sales
Some of the main moves in markets:
Stocks
· The S&P 500 fell 0.8% as of 4 p.m. New York time
· The Nasdaq 100 fell 0.5%
· The Dow Jones Industrial Average fell 1.3%
· The MSCI World Index fell 0.8%
Currencies
· The Bloomberg Dollar Spot Index rose 0.5%
· The euro fell 0.4% to $1.0898
· The British pound fell 0.5% to $1.2946
· The Japanese yen fell 0.7% to 157.37 per dollar
Cryptocurrencies
· Bitcoin fell 1.6% to $63,515.8
· Ether fell 0.4% to $3,401.64
Bonds
· The yield on 10-year Treasuries advanced four basis points to 4.20%
· Germany’s 10-year yield advanced one basis point to 2.43%
· Britain’s 10-year yield declined one basis point to 4.06%
Commodities
· West Texas Intermediate crude fell 0.8% to $82.21 a barrel
· Spot gold fell 0.7% to $2,442.61 an ounce
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