Is the Great Rotation Finally Taking Hold?
If smaller stocks continue to outperform, it will be a boon for stock pickers who focus on fundamentals and great charts.
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Political drama has been sucking up the oxygen in the room, but the Great Rotation is developing and gaining steam. It is now a near certainty that the Fed will cut interest rates a quarter point in September, which is driving the iShares 7-10-year Treasury Bond Fund IEF to its highest levels since early March and providing fuel for smaller stocks that are more leveraged to the cost of capital than the big-cap technology names.
The Russell 2000 IWM has had three straight days of sizable gains after a weak CPI report last Thursday morning, and it is gaping again on Tuesday. The rest of the market has had gains as well due to broader breadth, but the small-cap outperformance has been notable.
The key issue now is whether this rotational action is a new theme that will take hold and change the character of the market as we move through earnings season and start to anticipate the start of interest rate cuts.
Small-cap underperformance has been so pronounced for so long that it will take months or even years to close the gap in performance. If this really is the start of the Great Rotation, it will have a significant impact on market character and be a boon for stock pickers who look outside the Magnificent Seven names.
Market participants have been teased by a few bouts of rotational action in the past year, but it fizzled out, and the Nasdaq 100 went on to even more new highs on narrow breadth. While that could happen again, it will depend on the reaction to upcoming earnings. Will AI still be a catalyst for the inflow of capital into the expensive big-cap names that are the leaders in the AI industry, or will we start to see more small-cap names participate in the greatest technological advancement since the internet?
We are at a very interesting juncture with earnings season starting and the likelihood of interest-rate cuts becoming more certain. If smaller stocks continue to show good relative strength, it will be very beneficial for stock pickers who are focused on names with solid fundamentals and charts.
At the time of publication, Rev Shark had no positions in any securities mentioned.
