Traders shift investments from Big Tech to small-cap stocks as Fed prepares for potential rate cuts
The continuation of this year’s robust stock market rally hinges on the Federal Reserve's upcoming interest rate decision, according to BNN Bloomberg.
Since the July 11 consumer price index indicated cooling inflation, traders have shifted from Big Technology shares to small-capitalization stocks and value plays.
Investors have poured nearly US$6bn into non-tech sector US exchange-traded funds, compared to just $1.4bn into tech ETFs, according to Bloomberg Intelligence data.
For this trend to persist, Fed Chair Jerome Powell must set the stage for cutting interest rates in September, following the recent stringent monetary policy tightening.
Jimmy Lee, chief executive of the Wealth Consulting Group, emphasized the importance of this signal, “This equity rally that’s broadened may be turned upside down if the Fed doesn’t signal it’s cutting rates very soon.”
Lee has been buying tech and small-cap shares in anticipation of a September rate cut. “If Powell doesn’t stay stubborn, this bull market has more room to run,” he added.
Some argue for an immediate rate cut at this week’s meeting, considering the Fed’s preferred inflation gauge, the core personal consumption expenditures price index, rose by just 2.6 percent in June from a year ago, nearing the central bank’s 2 percent target.
However, Wall Street remains sceptical about an immediate cut.
The Fed last raised rates a year ago, keeping borrowing costs stable while monitoring inflation. If the Fed starts a rate reduction cycle, historical trends favour stock bulls. In the six previous hiking cycles, the S&P 500 Index has risen an average of 5 percent in the year following the first cut, according to CFRA.
The gains have also broadened, with the small-cap Russell 2000 Index climbing 3.2 percent 12 months later.
Since the Fed began its tightening campaign in March 2022, the S&P 500 has climbed 29 percent, though it has experienced significant volatility. After a severe downturn two years ago that pushed the equities benchmark into a bear market, it has rebounded to all-time highs, driven by enthusiasm for artificial intelligence.
Currently, price pressures appear contained, but traders worry that if the Fed doesn’t reduce borrowing costs, it risks causing turmoil in the banking sector and restricting credit in vital areas of the US economy.
Overly restrictive monetary policy in the 1970s and during the dot-com bubble caused economic harm.
Historically, the average time from the final rate hike to the first cut in the last seven tightening cycles has been 9.2 months, according to Sam Stovall, chief investment strategist at CFRA. It has been 12 months since the Fed’s last hike in July 2023, making this span longer than usual.
Traders face challenges as they navigate the rotation out of Big Tech with August and September—historically, the worst months for stock returns—approaching.
The Fed meeting coincides with expected earnings reports from Microsoft Corp., Meta Platforms Inc., Apple Inc., and Amazon.com Inc., with analysts projecting a slowdown in profit growth.
While another $1.2bn was invested in US small caps last week, according to EPFR Global, not everyone believes the rally, or the rotation theme will continue. Jeff Rubin at Birinyi Associates Inc. sees these moves as a typical correction, noting the Nasdaq 100 Index is down 7.4 percent from its July 10 high.
Nancy Tengler, chief executive officer at Laffer Tengler Investments, stated, “Rate cuts would need to be aggressive for those smaller companies to benefit, and we just don’t see that happening with the economy strong.”
History shows that buying stocks at the end of hiking cycles is a winning strategy in relatively low-inflationary environments like the 1990s.
However, when monetary easing follows inflationary pressures, as in the 1970s, stocks tend to fall in the three months after the last hike, according to Bank of America Corp.
Powell’s commentary this week is crucial to the ongoing struggle between bulls and bears.
Eric Beiley, executive managing director of wealth management at Steward Partners Global Advisory, emphasized, “Traders are pricing in action by the Fed very soon. It’s important officials act, or else stocks will be vulnerable in a seasonally weak and volatile time.”
