The Chips Are Down

Lower future rates trigger a rotation out of Tech, into smaller companies

If you kept your head under a rock this week, no worries we got you, and here is the gist of market activity: Markets price an almost certain rate cut in Sep24. Investors pivot out of fairly rich large cap growth companies, into smaller cap names. In bonds, there is a renewed appetite for duration. Fundamentals remain in check though, as 2Q24 earnings are being released, and consumer weakness is in focus.

At least, this is the overall narrative. And it’s true that tech stocks suffered some re-adjustment, with the star-of-the-show Nvidia falling by 12% over the past month. The reason? Well, a bit of profit taking after an eye-watering ascent, and also some reaction to political saber-rattling around tariffs that may impact the global chip trade.

Who benefits the crime? Value stocks, which in over-simplistic terms are meant to benefit from a lower rate environment. Indeed, the latter rallied by a stunning ~9% month-to-date leaving their large cap cousins in the dust.

More broadly, it was clearly a rotation out of the top 10 US stocks into the rest of the market. Such transition is best measured by an improvement in market breadth. For short, this measures the percentage of companies within a given index that trade above their 200-day moving average. Market breadth shot up dramatically in the past week, from 55% to 74% for Russell 2000 (aka “small caps”) but also for S&P500 from ~65% to 80%. In a sense, the 490 are catching up on the top 10.

Does it mean that the long-term lead of the top 10 names is over? Not too fast. For one, large companies still impress with higher earnings and pristine balance-sheet quality, which remain an strong asset to cling to in an economic slowdown. Second quarter earnings will tell whether this story holds, but my hint is that it does as the current slowdown disproportionately hurts smaller companies.

Having said that, there will be a point in a near future when quarterly earnings growth of the Russell 2000 will outpace S&P500. In that regards, small-cap look relatively cheap compared to large cap stocks, and some sort of positioning is warranted.

What is it for bonds then? As a starter, the equity risk premium has been negative. This is the natural consequence of higher equity prices, and relatively elevated 10-year yields. From this point on, fixed income looks attractive, notwithstanding that yields are expected to stabilize or decrease from here, thus boosting the price of bond assets.

Mind you though that the higher-for-longer mantra is challenged but has not yet disappeared. The reason why is that US treasury issuance is meant to increase over the coming years to fuel budget deficits, and rates need to remain high enough to attract international investors. However, it is fair to expect that short-dated yields will tapper from current level, thus making short-dated bonds a surer win. This is true for Government bonds, and the cream of the crop of investment grade. This comment applies with a pinch of salt to lower quality bonds though, where spreads at historic low could spring back to reflect higher credit tensions.

If US rates are meant to decrease, and the USD weaken, why not investing into foreign assets? Good thinking, there is indeed some macro positioning to be done and, for example, GBP-denominated assets enjoy some tailwind following the rather-conservative budget stance from the new Prime Minister’s financial team. The caveat is that earnings growth outside the US and Japan looks tepid, and fundamentals coming from Europe or China are yet to impress. So, cherry-pick wisely.

Gold then? A lower US dollar combined with geopolitical unrest should always benefit gold, which has rallied 16% year-to-date. At this point, the rally seems to be slightly overdone, and some profit-taking is happening, certainly following the higher certainty of the US election outcome in Nov24.

Last but not least, follow long-term trends. I believe that energy, climate, demographic, and technology transitions are powerful drivers. On this note, make sure you read the interview I’ve done with Dr Luc Julia, the co-founder of Siri, released next Wednesday 24th July.

When the chips are down, you are not alone. Reach out for more market insights, and investment solutions. Happy to help your thinking along the way. Mind you that, according to a Gallup poll, people who reported feeling lonely are a lot more likely to feel all other sorts of anxiety and stress. We are here for you, at least to assuage your market concerns.

Stay safe out there !

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Sources -

“The Chips are Down” song - Anais Mitchell

Return of small caps - SoFi

Tech bros love JD Vance. Many CEOs are scared stiff - The Economist