By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
After roughly a year and a half of the market favoring large technology and communications stocks, there was a notable rotation in July towards areas which have lagged such as small cap and defensive stocks. As measured by the Russell 2000 Index, small caps returned 10.2% in July compared to 1.2% for the S&P 500, which helped close the relative gap in year-to-date performance and price-to-earnings multiples (see chart below – as of 7/29). The Russell 1000 Value Index also outperformed the Russell 1000 Growth Index 5.1% to -1.7% in July as some major tech stocks like NVDA and MSFT faltered.
2025 will also be a tremendously consequential year for tax policy due to expiring tax cuts from the Tax Cuts and Jobs Act, along with potential changes in Affordable Care Act subsidies, Inflation Reduction Act provisions, and more. It is too early to tell what will happen to these expiring tax cuts at this point, but we doubt that taxes will return to pre-Trump levels even if they are higher.
The election continues to be a source of uncertainty since the U.S. is essentially a 50/50 country. As mentioned in prior commentaries, the S&P 500 has performed similarly under both parties historically and has done well in re-election years, but some heightened volatility leading up to the election would not be surprising. The results of the last debate also introduced the possibility of Democrats replacing Biden on the ticket, although that still seems unlikely since they don’t have many strong alternatives at this time.
Our sense is that this rotation was catalyzed by the June Consumer Price Index report, which was cool enough to make investors expect rate cuts in September. Rate cuts seem to favor smaller companies because they are more sensitive to the cost of debt. However, if the rate cuts are a sign of a potential slowdown, small caps can be more economically sensitive to earnings reductions. As such, we are hesitant to lean into the small cap rotation too heavily.
Additionally, the rotation occurred as some stocks levered to the artificial intelligence (AI) trade posted somewhat unimpressive earnings, leading investors to wonder whether the growth priced in for this theme was a little too generous. Semiconductors did rebound on the last trading day of the month as AMD beat expectations, but the tech sector was still down for the month. Earnings overall have broadened this quarter, with sectors like financials and healthcare experiencing healthy top-line growth and a higher number of stocks outperforming in July. The percentage of stocks outperforming the index over a 20-day rolling period (as of 7/30) has not been this high since 2001.
Whether the market rotation will continue through the second half of the year is anybody’s guess, and it did show signs of unwinding on the last day of July, but it reaffirms our conviction that there is value in owning names beyond the Magnificent 7. Market concentration is still very high, and we favor owning some exposure to both the segments of the market that have done and well and those that have fallen behind, rather than making an all-in bet on one side.
Furthermore, we are attracted to investments that are outside of semiconductors that can benefit from the digital transformation brought about by AI, like industrial and utility companies that help provide the infrastructure needed for the massive energy input that AI requires. According to the International Energy Agency’s 2024 electricity forecast, global electricity consumption from data centers could double by 2026, and more progress needs to be made to support that demand. Along with the increased need for digital infrastructure spending, we also see a need for increased spending to modernize aging infrastructure like roads, water systems, towers, and more. These are themes that could continue to benefit long-term whether the current rotation continues or not, and the valuations of most companies involved are not as stretched as many of the pure play technology companies.
In July the S&P 500 returned 1.2% while the Bloomberg US Aggregate Bond Index returned 2.3%. The Federal Reserve chose to keep rates in the 525-550bps range, and the 10-Year Treasury Rate fell from 4.36% to 4.09%
Charts provided by Strategas Research Partners, LLC and YCharts, Inc.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Daniel is a Senior Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.
August 2024 Commentary: Thoughts on the Recent Market Rotation
By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
After roughly a year and a half of the market favoring large technology and communications stocks, there was a notable rotation in July towards areas which have lagged such as small cap and defensive stocks. As measured by the Russell 2000 Index, small caps returned 10.2% in July compared to 1.2% for the S&P 500, which helped close the relative gap in year-to-date performance and price-to-earnings multiples (see chart below – as of 7/29). The Russell 1000 Value Index also outperformed the Russell 1000 Growth Index 5.1% to -1.7% in July as some major tech stocks like NVDA and MSFT faltered.
2025 will also be a tremendously consequential year for tax policy due to expiring tax cuts from the Tax Cuts and Jobs Act, along with potential changes in Affordable Care Act subsidies, Inflation Reduction Act provisions, and more. It is too early to tell what will happen to these expiring tax cuts at this point, but we doubt that taxes will return to pre-Trump levels even if they are higher.
The election continues to be a source of uncertainty since the U.S. is essentially a 50/50 country. As mentioned in prior commentaries, the S&P 500 has performed similarly under both parties historically and has done well in re-election years, but some heightened volatility leading up to the election would not be surprising. The results of the last debate also introduced the possibility of Democrats replacing Biden on the ticket, although that still seems unlikely since they don’t have many strong alternatives at this time.
Our sense is that this rotation was catalyzed by the June Consumer Price Index report, which was cool enough to make investors expect rate cuts in September. Rate cuts seem to favor smaller companies because they are more sensitive to the cost of debt. However, if the rate cuts are a sign of a potential slowdown, small caps can be more economically sensitive to earnings reductions. As such, we are hesitant to lean into the small cap rotation too heavily.
Additionally, the rotation occurred as some stocks levered to the artificial intelligence (AI) trade posted somewhat unimpressive earnings, leading investors to wonder whether the growth priced in for this theme was a little too generous. Semiconductors did rebound on the last trading day of the month as AMD beat expectations, but the tech sector was still down for the month. Earnings overall have broadened this quarter, with sectors like financials and healthcare experiencing healthy top-line growth and a higher number of stocks outperforming in July. The percentage of stocks outperforming the index over a 20-day rolling period (as of 7/30) has not been this high since 2001.
Whether the market rotation will continue through the second half of the year is anybody’s guess, and it did show signs of unwinding on the last day of July, but it reaffirms our conviction that there is value in owning names beyond the Magnificent 7. Market concentration is still very high, and we favor owning some exposure to both the segments of the market that have done and well and those that have fallen behind, rather than making an all-in bet on one side.
Furthermore, we are attracted to investments that are outside of semiconductors that can benefit from the digital transformation brought about by AI, like industrial and utility companies that help provide the infrastructure needed for the massive energy input that AI requires. According to the International Energy Agency’s 2024 electricity forecast, global electricity consumption from data centers could double by 2026, and more progress needs to be made to support that demand. Along with the increased need for digital infrastructure spending, we also see a need for increased spending to modernize aging infrastructure like roads, water systems, towers, and more. These are themes that could continue to benefit long-term whether the current rotation continues or not, and the valuations of most companies involved are not as stretched as many of the pure play technology companies.
In July the S&P 500 returned 1.2% while the Bloomberg US Aggregate Bond Index returned 2.3%. The Federal Reserve chose to keep rates in the 525-550bps range, and the 10-Year Treasury Rate fell from 4.36% to 4.09%
Charts provided by Strategas Research Partners, LLC and YCharts, Inc.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
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