The Great Rotation Is Here: What It Means and How To Play It
Momentum is building, and negative reaction to earnings from Alphabet and Tesla is helping to accelerate it.
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For more than two years, the primary stock market theme has been a narrow market primarily driven by big-cap technology names leveraged to AI and semiconductors. These massive stocks dominate the major indexes and have created the illusion of a roaring bull market.
The reality is that the vast majority of stocks have not participated in this bull market and that investors who hold diversified portfolios have mostly lagged. The business media has missed this story because, for them, the indexes are the only thing that really matters.
The one great certainty of the market is various cycles. The narrow big-cap index-driven cycle has lasted for quite a while, but it has finally started to shift.
There are a couple of catalysts that are fueling the shift. The first is the likelihood of interest-rate cuts and a slowing economy. The second is that there is such a divergence in valuation that the market is finally starting to favor the many stocks that have been lagging for so long. Big-cap technology has been a safe haven not because the stocks were good values but because they kept trending higher.
In recent weeks, we have finally seen the Russell 2000 IWM outperform and break out of a long period of consolidation. There are still many folks who are skeptical about this rotational action, but the momentum is building, and the negative reaction to the earnings from Alphabet GOOGL and Tesla TSLA is helping to accelerate it.
There are a couple of things to keep in mind about this rotational action. The first is that it will be very choppy. Big-cap technology is not going to go straight down, and the rest of the market isn’t going to go straight up. There should be some new sector themes that work much better.
I expect to see some countertrend moves as things develop. These big-cap technology names in the Nasdaq 100 QQQ that are being slammed Wednesday should see a countertrend bounce. One of my top plays on a bounce in the Magnificent Seven is Amazon AMZN.
The key thing to keep in mind when playing a rotation is the focus on stock picking. The rotational action provides a tailwind for the best-quality stocks. I like many small biotechnology names, and while the group may improve due to rotational action, the way you really boost your returns is by picking the best names in the biotech sector and not just the indexes or ETFs.
Another benefit of this rotation is that chart patterns start to work better. Technical setups work much better when there is rotational action to support them. Many great small-caps have languished for years while everyone piled into Apple AAPL and Nvidia NVDA, but now the charts are improving, which makes it much easier to design trading strategies.
So far, on Wednesday, we are seeing a trend down day in the Nasdaq 100. No one is dip buying the Magnificent Seven right now. Despite the Nasdaq 100 being down 2.5%, the Russell 2000 is close to flat.
The folks in the business media are going to stay focused on the major indexes and talk about how poor this action is. They will miss the real story once again, but astute traders will see some of the best opportunities in many years.
At the time of publication, Rev Shark was long AMZN.
