Signs of falling U.S. inflation on Wednesday and growing hopes for interest-rate cuts from the Federal Reserve could be a positive signal for large swathes of the stock market that have languished in a rally led by Big Tech.
Benign consumer price data fuelled bets the Fed will lower rates in coming months and sent the S&P 500 to fresh highs. Stocks held onto gains after the Federal Reserve left interest rates unchanged and Fed chairman Jerome Powell delivered an encouraging assessment of the economy.
Some investors believe expectations of cooling inflation and looser monetary policy could boost areas of the market that have been hurt by higher rates, including shares of small caps and financial companies. That could ease worries about the risks of a market rally that has been concentrated in a cluster of giant tech stocks.
Though the S&P 500 is up about 14 per cent this year, about 60 per cent of the return has been driven by six companies whose shares have an outsized weighting in the index: Nvidia, Microsoft, Apple, Meta Platforms, Alphabet Inc. and Amazon.com, data from S&P Dow Jones Indices showed.
If Wednesday’s CPI report is the start of improved data that raises chances of rate cuts, “that can bring the whole yield curve lower, benefiting some of the areas that have been sensitive to the upside in yields,” said Angelo Kourkafas, senior investment strategist at Edward Jones, including small caps and some economically sensitive stocks such as financials and industrials.
Short-term interest-rate futures are now pricing in more than a 70-per-cent chance of a rate cut by September, up from only slightly better than a coin toss earlier in the day.
While technology and growth stocks have powered stock indexes higher in recent years, interest rate-sensitive areas of the market have often surged when hopes of easier monetary policy came to the fore.
One such episode came in the final months of last year, when small caps soared on expectations the Fed was done cutting rates. The small cap-focused Russell 2000 gained 13.6 per cent in the final quarter of 2023, compared to an 11.2-per-cent gain for the S&P 500.
“The Fed doesn’t even need to cut in July as we expect, it just needs to be heading towards that rate-cut cycle, if you will, and that should contribute to broadening performance,” said Luke Tilley, chief economist at Wilmington Trust.
“Our view is not just that there is room for broadening, but that we fully expect that,” he said.
Some broadening was evident on Wednesday. Though shares of market leaders such as Apple and Nvidia surged, the small-cap focused Russell 2000 was up around 2.2 per cent against a 1.1-per-cent rise in the S&P 500. The small-cap index was down 0.1 per cent for the year heading into Wednesday’s report.
Other areas bouncing back on Wednesday included the S&P 500 banks index, up 0.6 per cent, although it remained in negative territory for the quarter. The Dow Jones Transportation Average was up 0.9 per cent on the day, while the S&P 500 real estate sector gained 1.1 per cent; both groups are still logging declines on the year.
The equal weight S&P 500 – a proxy for the average stock in the index – was up 0.7 per cent. It has gained just 4.5 per cent this year.
To be sure, investors were sticking with some of this year’s winners, too. Technology, the best performing S&P 500 sector this year, was up 2.9 per cent on the day, including gains of more than 4 per cent each for Nvidia Corp. and Apple.
At the same time, investors are likely to be cautious when it comes to cutting exposure to tech in favour of other areas of the market. The tech-heavy Nasdaq 100 has outperformed the Russell 2000 by about 24 percentage points over the last year. Looking back further, the performance gap is even wider: 50 per cent over two years and 53 per cent over five years, according to LSEG data.
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