What We're Seeing: Rotation Emerges – 24 June 2024

The Week in Brief

A broader market rotation emerged last week. Early in the week, the Russell 2000 and other small and mid-cap indices surged, hitting multi-year highs. This marked a continuation of the shift out of mega-caps that had been building for weeks.

Tech leaders cooled off significantly. NVIDIA and most chip stocks fell 6 to 7% as profit-taking set in after an extraordinary run. The Dow hit a one-month high, while the S&P 500 ended slightly down for the week. It was a tale of two markets: the old economy rising as the new economy took a breather.

Sector Leadership

Energy stocks led sector gains, up 2.7% on a pickup in oil demand expectations. The sector has been remarkably resilient, benefiting from disciplined supply management by OPEC+ and steady global consumption.

The rotation into value and cyclicals reflects a broadening of investor confidence. When money flows into smaller, more economically sensitive companies, it suggests that investors believe the expansion has legs. This is distinct from the narrow, quality-driven rallies we saw earlier in the year.

Fixed Income and Global Markets

The bond market paused after its summer rally. US yields were relatively unchanged on the week, holding near recent levels. Europe’s yields dropped on slowing growth fears, highlighting the divergence between the US and eurozone economic trajectories.

The dollar held firm, supported by the yield differential. This creates headwinds for US multinationals but benefits domestic-focused companies.

Our Read

The rotation is the story. We have been waiting for breadth to improve, and last week delivered. Small caps and cyclicals are playing catch-up after months of underperformance relative to mega-cap tech.

This does not mean tech is broken. The fundamental case for AI and cloud computing remains intact. But valuations had stretched, and some consolidation is healthy. NVIDIA shedding a few percentage points after doubling in six months is not a cause for alarm.

For positioning, we are leaning into the rotation. Small-cap exposure makes sense at current valuations, particularly for companies with domestic revenue exposure. Energy remains attractive as a geopolitical and inflation hedge. We are trimming some tech positions where valuations have become extreme but maintaining core holdings in quality names.

What Could Change Our View

The rotation could reverse if economic data weakens, prompting a flight back to defensive mega-caps. We would also reassess if oil prices spike uncontrollably, as that would pressure consumer spending and margins. The key is distinguishing between a healthy rotation and a change in trend. So far, this looks like the former.

This is informational commentary, not investment advice.