Rotation Continues

With data showing inflation easing, the sectors and companies leading the market continue to rotate. While mega-caps are adjusting after a period of growth, pockets of smaller large-caps, mid-caps, and small-caps are on the rise. Bond yields have dropped in anticipation of rate cuts, relieving pressure on a wide range of stocks. The momentum in the largest stocks is slowing, causing the top-heavy S&P 500 to dip, though the equal-weight index, which values all stocks equally, remains near its all-time high. Ultimately, the fundamentals are key. Even though earnings for the biggest stocks might fall short of expectations, they remain solid. We expect earnings growth to extend beyond the largest companies as the year continues. With plenty of investment capital available, stock pickers have many opportunities.

The Federal Reserve’s preferred measure of inflation, the Personal Consumption Expenditures Price Index (PCE), which tracks changes in the prices of household goods and services, declined in June. PCE matched expectations at 2.5% year-over-year, down from 2.6% the previous month. Inflation is slowly moving towards the Fed’s 2% target. This trend gives Fed officials more confidence in their plan to cut rates, likely resulting in at least two quarter-point cuts by year-end. Bond yields across various maturities are falling in anticipation of rate cuts, especially bonds with shorter durations. These lower yields could encourage investors to move some of the $6 trillion currently held in money market funds. As a result, dividend stocks have performed better and are becoming more attractive.

While the market is broadening, it is too soon to dismiss mega-caps stocks entirely. Eventually, some earnings were bound to disappoint due to high expectations. Several AI-levered companies have yet to report earnings, but a softer Alphabet (GOOGL) report suggests this possibility. Still, 31% earnings growth year-over-year is nothing to scoff at. AI continues to be a significant long-term trend, driving growth and innovation across various industries. We hope to see AI contribute to the broadening of earnings as well. Earnings growth is expected to accelerate for the "average" stock in the third and fourth quarters, partly due to AI adoption and development. The sustainability of this broader growth depends, at least in part, on these factors.

The upcoming election adds uncertainty as we move closer to November. Historically, re-election years have been strong for the market, but with Biden not running, this is more like an open election. In open years, market performance has been weaker, though still positive. There will likely be more surprises, but so far, the market has handled the recent unprecedented series of political events well. Companies will adapt, but there will be definite winners and losers depending on the outcome. We will continue to adjust our strategies as needed. 

Thanks,
Preston May, CBE®
Research Analyst