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The 'Magnificient 7' have had a tough month. The seven largest U.S. tech stocks have lost about 100 p.m. in recent weeks $1.75 trillion market value. According to several experts, we are currently witnessing a Great Rotation. What does this mean and what are the possible consequences for an investment portfolio?
On 5 July, we published an article in which we Arguments suggesting that the big tech stocks are overvalued. Since then, these stocks have taken a beating, with many even losing more than 10 percent. Last Wednesday, U.S. stock indices experienced their Worst day in just over 18 months. The S&P 500 fell 2.3 percent, and the tech-heavy Nasdaq fell 3.6 percent. For both, this is the biggest drop since the end of 2022. These losses were driven by the performance of the big tech stocks: Amazon, Apple, Alphabet(Google), Meta, Microsoft, Nvidia and Tesla.
Tech giants' performance since July 5 (source: ycharts.com)
Tesla's stock lost as much as 12.3 percent in a single day on disappointing earnings. Tesla's net profit of $1.47 billion for the second quarter fell well short of analysts' Expected $1.9 billion. This was partly due to slower deliveries of vehicles. Nvidia's stock fell 6.8 percent on Wednesday and Alphabet, Google's parent company, fell 5 percent on the same day on disappointing ad revenue.
The AI optimism around technology stocks now seems to be cooling. As long as profits continue to rise, there is a certain logic behind the record highs. But the largest stocks have now grown so large relative to the economy as a whole that investors suspicious should be about the sustainability of profit margins and profit growth rates. The rally in the largest U.S. technology stocks is therefore also at risk of weakening further if the U.S. economy continues to cool, according to Michael Hartnett from Bank of America.
Just like others he sees signs of a rotation into stocks that have lagged behind the relatively expensive tech giants lately. It is not the case that all shares have lost market value in the past month. A rotation implies that investors sell large-cap stocks and use the proceeds to buy small-caps. The Russell 2000 index, which tracks small-cap stocks, rose about 11.5 percent in just five days in mid-July, its biggest increase since April 2020.
Russell 2000 performance since July 5 (source: ycharts.com)
The outlook for small-caps changed when it published on July 11 Inflation Report showed that inflation has cooled further. This paves the way for the Federal Reserve to cut interest rates. This can be advantageous for smaller businesses that are suffering from higher financing costs. In addition, it can affect the tech giants because they have a lot of cash on the balance sheet and receive less interest income on these reserves.
The rally accelerated after the failed assassination attempt on Trump seemed to boost the chances of his victory. Trump has plans to raise tariffs and cut taxes. This can be advantageous for smaller businesses.
Tom Lee of Fundstrat sees a lot of opportunity in the smaller stocks while he expects the S&P 500 to remain roughly flat in the coming month. He indicated that he had seen an increase of in total 40 percent expected in small-cap stocks of which 15 percent in August, after being largely left out of this year's broader rally.
"I think the narrative has changed," said Eric Kuby, chief investment officer at North Star Investment Management Corp, which specializes in small-cap stocks. "I hope this is just the beginning of what could be a very long, multi-year period where small-caps can make up a lot of ground."
Not all analysts are convinced of a big rotation. John Higgins Capital Economics argues that the recent rebound in small-cap stocks is likely to be short-lived. He argues that there is no true rotation yet, as major stocks are still close to their all-time highs. He emphasizes that the most important factor driving the stock's performance is its earnings. According to him, there are no signs yet that small-caps will outpace the big stocks with earnings growth.
Whether there will actually be a prolonged major rotation therefore depends on further sell-offs of the big technology stocks and relatively faster earnings growth for the smaller companies.
Another theory about a large rotation is that of Crescat Capital. The asset manager thinks we are on the verge of a Great Rotation. They expect capital to shift from overvalued financial assets to undervalued commodities, especially in the energy and metals markets. We previously wrote a Extended article about their theory'The Rise of Hard Assets’. It's a convincing story, but it's important to mention that they've already told this story. since 2021 tell. We'll see in the near future whether they're going to be right.
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On behalf of Holland Gold, Paul Buitink interviews various economists and experts in the macroeconomic field. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here to subscribe.
