Something appears to have shifted in the stock market. For the moment, at least.
For the first half of this year, technology stocks — especially those linked to the expected boom in artificial intelligence — propelled major indexes around the world higher.
The tech sector has risen faster than any other sector and twice as quickly as all of them this year, except for communications companies, which include the likes of Amazon ( AMZN). Just a handful of stocks accounted for nearly two-thirds of the gains in the S&P 500 ( .SPX) this year. Given their influence over the broad market, it was a rally that led to some worrying conclusions about what might happen if it lost steam.
That may be happening. Investors are growing confident that the Federal Reserve will start to lower interest rates soon, which could spur spending and give the economy a lift. Shares of businesses that could benefit from this growth — smaller companies, banks and real estate businesses — have all rallied in the past two weeks, while Big Tech has stumbled.
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It’s still early, but some analysts and investors see it as a sign that the stock-market dominance of companies such as Nvidia ( NVDA) and Microsoft ( MSFT) may be starting to wane. It might not be a smooth transition — as trading on Wednesday, when stocks had their worst day since late 2022, showed.
Big companies have a big impact on the stock market because even small changes in their share prices can create and destroy billions of dollars of value for investors. Replacing the tech stocks with a wider swath of smaller companies as leaders is not guaranteed to produce the same ferocious rally that occurred in the first half of the year.
“I think it’s a little putting the cart before the horse,” said George Goncalves, the head of U.S. macro strategy at MUFG Securities. “And it’s a small cart.”
A rotation has begun
On trading desks, this changing leadership in the stock market is called a “rotation.”
It began in earnest this month after new inflation data, which confirmed that price increases continued to slow in June, crystallized the view that the Fed will begin to cut interest rates in September.
If the Fed takes its foot off the economic brakes, companies that benefit from increased consumption — as the cost of borrowing to buy a house, or expand a business, begins to decline — stand to fare well.
The Russell 2000 index ( .RUT) of smaller companies had its best day of the year on July 11, after the release of one inflation report. The index shot 3.5% higher, far outperforming the 0.9% slide for the bigger companies that make up the S&P 500.
It wasn’t just a single day: Roughly $10 billion flowed into funds that buy small companies for the week through July 17, the biggest one-week inflow since 2007, according to data from EPFR Global.
Other, more mundane factors are at play, too. On Wednesday, for example, big tech stocks cratered after Tesla ( TSLA) and Alphabet ( GOOGL) both reported earnings that left investors disappointed. Small stocks fell too, but not by as much.
The Russell 2000 has now gained more than 7% in July, its best monthly showing this year, compared with a drop of 0.6% for the S&P 500. In the options market, traders are betting on this trend to continue.
But will it last?
Few analysts are predicting that the tech rally will fade completely. Instead, they’re expecting the other companies to catch up (to some extent) as lower borrowing costs bolster the economy.
But even if tech stocks continue to lead the S&P 500 in earnings growth, their abnormally stellar stock-price performance of the past year is unlikely to carry on, said Parag Thatte, an equity analyst at Deutsche Bank.
“For everybody else, we think the direction of travel is clearly on the way up, not down,” he said.
That doesn’t mean the rally has to stop altogether, though. “We think we can have a market rally even if tech companies underperform,” Thatte said.
Other investors are less confident that a new order is about to take hold. On Monday, analysts at BlackRock’s Investment Institute said that “looking through the noise,” they expected tech to still dominate the stock market. While interest rates may be about to move lower for the first time in more than four years, they’re unlikely to fall as quickly as they rose, and that could undercut the rotation.
Instead of monetary policy or politics, “we think the market is being driven by structural shifts like AI that are spurring a transformation,” the analysts wrote.
There is also the lingering risk that the rate cuts may be coming too late.