This past week has been quite the ride for investors, especially those keeping an eye on small-cap stocks. After a second quarter dominated by the mega-cap tech giants like Microsoft, Meta, Amazon, Apple, NVIDIA, Alphabet, and Tesla, things took an exciting turn. Last week’s encouraging inflation data and rising expectations of Federal Reserve rate cuts have sparked a broader stock rally, pulling in smaller stocks into the mix.
The Magnificent 7 tech stocks had a stellar second quarter, surging almost 17%. In contrast, the average small and mid-cap stocks, as well as the S&P 500, saw declines. But last week, small-cap stocks, as represented by the Russell 2000, shot up by 6%, though they still lag behind on a year-to-date basis.
What’s driving this change? The increasing conviction that the Federal Reserve will start cutting rates soon. This belief has boosted economically sensitive cyclical stocks, pushing them to new highs compared to less sensitive defensive stocks. Investors are growing more confident that the Fed can navigate these economic waters without triggering a recession, which is great news for smaller, more economically sensitive stocks.
June’s inflation data added to this optimism. The Consumer Price Index (CPI) and the more detailed supercore measure of services inflation showed better-than-expected readings, with the year-over-year pace of CPI inflation easing to 3.0%. This continued easing of inflation pressures, along with softer labor market data, has markets betting heavily on a rate cut in September. In fact, the odds of a September rate cut have now hit 100%, with markets anticipating at least two cuts of 25 basis points each in 2024.
Treasury yields have also fallen, reflecting this growing confidence. The 2-year Treasury yield, which was around 5% in May, has now dropped to 4.45%. This decline is another signal that markets are gearing up for the Fed to start easing rates.
As we dive deeper into the second-quarter earnings season, the mood is cautiously optimistic. Over 80% of companies that have reported so far have beaten earnings estimates. Big names like JPMorgan have set the tone with significant earnings beats, boosting overall expectations for second-quarter earnings growth. This week, we’ll hear from companies like Johnson & Johnson, Prologis, and Netflix, adding more color to the earnings picture.
Retail sales data for June will also be a key indicator to watch. U.S. consumers, the backbone of economic growth, seem to be slowing down, so any changes in retail sales growth will be closely scrutinized. Plus, with ten Fed speakers scheduled this week, including a crucial interview with Fed Chair Powell, all eyes will be on how the Fed reacts to the recent inflation and labor market data.
So, get ready for more market action as we move through July. Keep an eye on those small caps and stay tuned for more Fed signals!
