S&P 500’s next leg up hinges on battered stocks getting revenge

As the share index went from one record to another in the first half of 2024, some grew concerned that few members outside of tech giants were participating in the rally

Strategas Securities' Todd Sohn said: 'While all of the best players from Nvidia to Microsoft pause their rally, the rest of the team is holding up their end of the bargain.' 

Corners of the stock market outside of Big Tech are barrelling higher as traders grow more confident about interest-rate cuts in the near future thus fuelling hopes that another leg of the bull run could be in the offing.

A version of the S&P 500 that strips out market-cap bias just posted the best two-week stretch relative to the S&P 500 since November 2020.

This is a notable shift for the equal-weighted index that has trailed the benchmark gauge for months, and it comes as optimism over eventual monetary easing is pushing investors away from the perceived safety of big tech.

“This is all about the bench of the stock market finally stepping up,” said Todd Sohn, managing director of ETF and technical strategy at Strategas Securities. “While all of the best players from Nvidia to Microsoft pause their rally, the rest of the team is holding up their end of the bargain, with the most neglected groups catching a bid.”

With the S&P 500 Index and Nasdaq 100 Index posting their worst weeks since April, investors are now asking whether performance in roughed-up groups will continue and what stocks will do when the Federal Reserve eventually does cut rates.

Historically, interest-rate cuts have ushered in strong stock market returns — but only for cycles that are not triggered by a recession, like this one. Easing cycles tended to spur gains in rate-sensitive groups such as utilities, staples and health care.

As the S&P 500 marched from one record to the next in the first half of the year, some on Wall Street grew concerned that only a handful of members outside of technology giants were participating in the rally.

To see just how top-heavy the S&P 500 Index has become, consider this: since the bull market began 21 months ago, the S&P 500 has gained 54% while its equal-weight peer has added just 31%. At this point of a bull-market run during four previous cycles, the equal-weight index has outpaced the cap-weighted benchmark by 15 percentage points, on average, data compiled by Bloomberg show.

The S&P 500 has gone nowhere but up for months — advancing in 28 out of 38 weeks since its near-term low in late-October — and fund managers are starting to boost exposure in sectors beyond technology megacaps. Small caps had their second-largest inflow ever at $9.9bn (€9bn) in the week to Wednesday, according to data compiled by EPFR Global and Bank of America.

Jim Paulsen, a well-known stock strategist who correctly called this month’s rebound in previously forgotten corners of the market, predicts companies outside of tech will support the next phase of the bull market. He said: 

It’s a rare feat historically to have what many people perceive as a bubble being deflated without igniting a much larger selloff.

"The crucial question is whether there can be a pullback in big-tech stocks that slightly reduces their hefty concentration without having a massive rout more broadly.”

The S&P 500 traded 15% higher than its 200-day moving average at some point last week. That kind of gulf preceded losses for the index in 2011, 2015 and 2018, data compiled by Andrew Thrasher, technical analyst and portfolio manager at Financial Enhancement, show.

The S&P 500 just exited what has historically been its best two-week stretch of the year in the first half of July, and is approaching its most challenging stretch in August and September.

Further potential catalysts include the start of the tech earnings later this month as well as the US government’s first reading on second-quarter gross domestic product, due on Thursday, and the Fed’s preferred measure of inflation on Friday. All of that may provide insight into the rate outlook and, ultimately, the direction of stocks.

The consensus expectation is that economic growth will remain sturdy, with the Atlanta Fed’s GDPNow model projecting second-quarter real GDP growth climbing to a 2.7% annual rate, from a 1.4% pace in the first quarter.

“Investors won’t tolerate owning companies that struggle with profit growth for more than a quarter,” said Julie Biel, a portfolio manager at Kayne Anderson Rudnick. “But whenever there’s any whiff of a change in rotation, money managers chase it because it profoundly benefits their portfolio performance — if they catch it early.”

• Bloomberg