Stocks climb as Fed bets rekindle broadening trade

The stock market got a boost at the end of a wild week after key economic data bolstered speculation the Federal Reserve will set up the stage for an interest-rate cut in September.

Every major group in the S&P 500 rose Friday on bets that a Fed easing cycle will keep fueling Corporate America – with the bull market broadening beyond a narrow group of companies. While big tech has enjoyed massive gains this year, the so-called concentration risk has come to the forefront after a disappointing start of the megacap earnings season.

The rotation into economically sensitive shares has been fueled by Fed-friendly data. Investors who for months saw fewer alternatives to a tight group of market winners were suddenly faced with more choices. Financial, industrial and staples shares have largely beaten tech in July. Small caps have rallied 10% on bets they’d do better amid lower rates given their higher debt loads.

“We’ve seen this strength in small caps – a significant rotation not seen in decades,” said George Maris at Principal Asset Management. “As we see earnings likely broaden out and recover, you’re going to see greater enthusiasm for those smaller cap names. There is going to be lasting power to this rotation.”

Friday’s economic data reinforced those bets. The Fed’s preferred measure of underlying U.S. inflation – the core personal consumption expenditures price index – rose at a tame pace in June and spending remained healthy. U.S. consumer sentiment eased in July to an eight-month low.

“The prospect for interest-rate cuts has helped underpin the surge-like move into smaller names,” said Quincy Krosby at LPL Financial. “Still, there has been a prevailing concern that because small caps require a solid economic landscape, a weaker U.S. economy could easily hinder investor interest.”

The S&P 500 rose 1.1%. The Dow Jones Industrial Average climbed 1.6%. The Nasdaq 100 added 1%. The Russell 2000 of small caps climbed 1.7%. Homebuilders hit a record high. 3M Co., the iconic maker of Post-it notes, soared the most since 1980 on a bullish outlook. An initial public offering for Bill Ackman’s U.S. closed-end fund was postponed.

Treasury 10-year yields dropped five basis points to 4.19%.

An equal-weighted version of the S&P 500 – one that gives Target Corp. as much clout as Microsoft Corp. – beat the U.S. equity benchmark for a third straight week.

This is a notable shift for the measure that’s trailed the S&P 500 for months.

And it comes as optimism over eventual monetary easing pushes investors away from the perceived safety of tech megacaps.

“A meaningful rotation from large-cap growth into SMID-cap value has been underway, and we think that will continue,” said Craig Johnson at Piper Sandler. “Our breadth indicators confirmed this seismic shift, along with the technical evidence that investors are reducing their concentration risk in the ‘Lag’ Seven and other large-cap leaders.”

The Fed is likely to signal next week its plans to cut interest rates in September, according to economists surveyed by Bloomberg News, a move they say will kick off reductions each quarter through 2025. Nearly three-quarters of respondents say the U.S. central bank will use the gathering to set the stage for a quarter-point cut at the following meeting in September.

“It seems the tide has finally turned,” said David Russell at TradeStation, in comments addressing the latest inflation data. “Investors can now focus on the big earnings next week and worry less about prices and rates.”

“Next week’s earnings reports from a heavy package of mega-cap tech names, will be a crucial test for a market that is trying to find direction amid mixed economic data and underpinned by a historically negative seasonal pattern,” said Krosby at LPL Financial.

Traders will be on the lookout for a raft of earnings from big tech.

The stakes were already elevated for the group heading into this earnings season. They just got a lot higher after a rout fueled by this week’s underwhelming results from a pair of megacaps. Apple Inc., Microsoft Corp., Amazon.com Inc. and Meta Platforms Inc. are all due to report earnings next week.

“The ‘earnings issue’ will probably still be the more important one as we move into the month of August,” said Matt Maley at Miller Tabak + Co. “If this earnings season continues to weigh on the tech stocks, there is a good chance that it will cause investors to start to ‘rotate’ into cash – instead of the small cap stocks.”

The rally in the biggest U.S. technology stocks is at risk of fading further if the U.S. economy continues to cool, according to Bank of America Corp.’s Michael Hartnett.

The strategist – who is bullish on bonds for the second half of 2024 – has said signs of an economic slowdown would fuel a rotation into stocks that have lagged behind the pricey tech megacaps this year.

Hartnett said recent data suggested the global economy was “ill,” and that “we are one bad payroll away” from big tech stocks losing their dominance.

Now here’s a piece of advice from Strategas: fear the cut, not the pause – for markets and earnings.

The market tends to perform much better during the period between the last hike in a Fed tightening cycle and the first cut in rates than it does after the first cut in the Fed Funds rate, according to Jason De Sena Trennert and Ryan Grabinski at Strategas.

On average, the market bottoms 213 days later and 23% lower after the first Fed cut in a series of rate cuts. S&P 500 operating earnings decline by about 10% on average in the 12 months following the first easing, according to Strategas.

Corporate highlights

• Honeywell International Inc. is considering an initial public offering of its majority-owned quantum computing firm Quantinuum as soon as next year, according to people with knowledge of the matter.

• Apollo Global Management Inc. has agreed to buy International Game Technology Plc’s gaming division and the gambling machines company Everi Holdings Inc. in a $6.3 billion, all-cash deal that will see the two businesses merged.

• Apple Inc. lost ground in China’s smartphone market in the June quarter after local companies like Huawei Technologies Co. surged ahead.

• Dexcom Inc. plunged after the maker of blood sugar monitoring devices for diabetics unexpectedly slashed its 2024 sales guidance, catching Wall Street by surprise.