S&P 500 Index Nearly $18 Trillion ‘Expanding’: Market Report

(Bloomberg) — Stocks hit all-time highs as bets that the Federal Reserve will soon start cutting interest rates sent a rush to the riskiest corners of the market.

Most Read from Bloomberg

Wall Street’s pattern of money circling into small-cap companies and out of “safety” into large-cap companies has extended since last week’s weak inflation data. Over the past four sessions, the Russell 2000 has outperformed the Nasdaq 100 by about 12 percentage points — a feat not seen since 2011. An equally weighted version of the S&P 500 — where the likes of Nvidia Corp. carry the same weighting as Dollar Tree Inc. — has outperformed the benchmark U.S. stock index. The index is less sensitive to gains than the largest companies — offering a glimmer of hope for a broader rally.

“Rotation is the name of the game,” said Andrew Brenner of NatAlliance Securities. “This is in line with the growing perception of lower interest rates.”

Brenner highlighted the fact that Russell 2000 futures were up around 4 a.m. New York time — while Nasdaq 100 futures were down. “That means foreign money, big money, made very large trades overnight,” he said.

If the Fed can cut interest rates significantly in a soft landing, there will be better prospects for accelerating earnings growth in lower-quality, cyclical sectors of the market, says Solita Marcelli of UBS Global Wealth Management. At Interactive Brokers, Jose Torres cited another potential reason for the rally in smaller companies: they tend to be more domestically oriented and are seen as benefiting “disproportionately” if Donald Trump wins the election.

The S&P 500 rose to 5,667 points, a record 38 points this year. The Dow Jones Industrial Average rose 1.85%. The Russell 2000 gained 3.5%, its biggest five-day gain since 2020. The Nasdaq 100 was little changed. The 10-year U.S. Treasury yield fell 7 basis points to 4.16%. Gold hit a record high.

Traders also waded into earnings. Bank of America Corp. delivered a better-than-expected net interest income forecast. Morgan Stanley traders joined the party across Wall Street in the second quarter even as the company’s larger wealth business failed to meet expectations. Charles Schwab Corp. warned it would have to scale back its business to protect profits.

The story continues

While the expansion in U.S. stocks is seen as a positive sign, the rise in small-cap stocks in such a short period shows signs of overpricing. In just five days, the Russell 2000 has jumped nearly 12% — its highest level since 2017.

“History was made today when the Russell 2000 closed 4.4 standard deviations above its 50-day moving average,” according to Bespoke Investment Group. “No other major U.S. index (the Dow since 1900, the S&P 500 since 1928, and the Nasdaq since 1971) has ever closed at such an extreme level.”

Matt Maley of Miller Tabak says the index has reached an overbought condition followed by declines over the past two years.

“This could indicate that the small-cap sector needs some sort of short-term respite,” he noted. “At the very least, investors should be cautious about pursuing these stocks in the near term.”

In that case, he said, it would be interesting to see if there is a reversal of the “rotation.” Tech stocks are recovering from their overbought status, so there’s no guarantee they’ll advance while small-cap names are falling, he said.

The bottom line is that if tech stocks and small-cap companies fall at the same time, it could cause “some problems for the market overall,” he noted.

The move on the Russell 2000 is bullish, but investors should be prepared for potential profit-taking or consolidation in the coming sessions, said Dan Wantropski of Janney Montgomery Scott.

“The longer-term monthly chart of the Russell 2000 shows a better picture of its potential,” he noted. “We believe the Russell 2000 could return to all-time highs as the average’s return to relative strength highlights more sector bandwidth ahead of this year’s leader (Tech/AI/MAG 7).”

Wantrowski also noted that the scope of participation in the broader market has improved since last week’s CPI rise.

“The battle between the broader markets and the 2024 leadership is expected to continue in the short term in our view, as the relative strength differences between these groups suggest the potential for further rotation in the future,” said Wantrupski. “This cannot be confirmed as a long-term investment trend/theme at this time. So for now, we continue to treat this as a trading opportunity (reverse move).”

Craig Johnson of Piper Sandler says it’s too early to tell whether a sustainable cycle can be maintained. More time and technical evidence are needed to confirm that sustained, broad-based participation that could lift the market higher is underway.

“The current (and long-awaited) expansion in equity gains is welcome, but high valuations will limit further upside to low single digits overall for the rest of the year,” said Robert Teeter of Silvercrest Asset Management.

For RBC Capital Markets’ Lori Calvasina, earnings season will be a “major test” for the rotation trade. Valuations and attitudes set the stage for an eventual transition to new leadership, but there were a few false starts, she added.

The relative performance of the Nasdaq versus the Russell 2000 has been on a wild ride since 2020, with each outperforming the other by more than 40 percentage points over various one-year holding periods since the pandemic, according to Nicholas Colas of DataTrek Research. The dramatic outperformance of small-cap companies only happened after tech stocks crashed or when individual investors created a small-cap bubble, he said.

“Neither of these settings is relevant now,” he noted. “We believe the Nasdaq will outperform the Russell by its 2003-2019 average of 2 points over the next year.”

As for whether the S&P 500 or Russell 2000 will outperform each other over the rest of the year, his view is that both will do equally well now — but not at the same time because of their low correlation.

“Right now, small-cap companies are having better momentum because money managers can’t afford to stay underweight as they have been for the past 18 months,” Colas said. “Once they’re reweighted, the S&P should be able to catch up.”

The S&P 500 had gone 351 sessions through Tuesday without falling 2%. If the benchmark stock index reaches 352 by Wednesday’s close, it would be the longest stretch since the start of the global financial crisis in 2007. The index went about 950 sessions from May 2003 to February 2007 without a similar decline.

The stock market’s strength has been fueled by optimism that the economy has weathered the worst of the Fed’s tightening. In that regard, Tuesday’s better-than-expected retail sales report was a “healthy” development, according to eToro’s Brett Kenwell. He noted that it’s better to see the Fed cut rates because of low inflation than to see the central bank rush to support a weak economy.

The Dow also had a “great day” amid hopes of lower interest rates, tax cuts and regulatory reforms — which could be on the horizon, according to Chris Zaccarelli of Independent Advisor Alliance. He also cited hopes that the market’s rally could broaden from a narrow band of technology stocks to “a cluster of companies.”

The company’s most prominent achievements:

• Goldman Sachs Group Inc. and Wells Fargo Inc. joined rival JPMorgan Chase & Co. in tapping the U.S. investment-grade market after reporting second-quarter earnings.

• PNC Financial Services Group Inc. posted its first increase in net interest income since the end of 2022, setting it up for what it expects to be a record year of net interest income growth in 2025.

• Microsoft Corp.’s investment in Inflection AI will be subject to a full investigation by the U.K.’s antitrust authority, after the watchdog said it needed to take a closer look at the hiring of former employees from the artificial intelligence startup.

• Philip Morris International is expanding production of Zyn in the U.S. as the popular oral nicotine pouches become harder to find due to increased demand.

• Starboard Value has become the third activist investor this year to take a stake in Match Group Inc., the owner of dating app Tinder, whose paying customer base has shrunk for six straight quarters.

• Adidas Inc. raised its annual profit target for the second time in three months amid growing demand for classic sneakers like the Samba and more sales from shrinking inventory of Yeezy sneakers.

Main events this week:

• Eurozone CPI, Wednesday

• U.S. housing starts, industrial production rise Wednesday

• Federal Beige Book, Wednesday

• Federal Reserve Board Member Thomas Barkin speaks Wednesday.

• ECB interest rate decision, Thursday

• US Initial Jobless Claims, Philadelphia Fed Manufacturing, Conference Board LEI, Thursday

• Mary Daly, Lori Logan and Michelle Bowman of the Federal Reserve speak Thursday.

• Fed’s John Williams and Raphael Boucek speak Friday

Some key movements in the markets:

Stores

• The S&P 500 was up 0.6% as of 4 p.m. New York time.

• The Nasdaq 100 was little changed.

• The Dow Jones Industrial Average rose 1.85%.

• MSCI World Index rose 0.4%

• The Russell 2000 index rose 3.5%.

Currencies

• The Bloomberg Dollar Index was little changed.

• The euro was little changed at $1.0901.

• The pound was little changed at $1.2974.

• The Japanese yen fell 0.2% to 158.39 yen per dollar.

Cryptocurrencies

• Bitcoin rose 2.2% to $65,153.51

• Ether rose 1.1% to $3,474.43

Bonds

• The yield on the 10-year US Treasury note fell seven basis points to 4.16%.

• The yield on German 10-year bonds fell five basis points to 2.43%.

• The yield on the 10-year British bond fell five basis points to 4.05%.

Goods

• West Texas Intermediate crude fell 1.3% to $80.87 a barrel.

• Spot gold rose 1.9 percent to $2,468.56 an ounce.

This story was produced with the help of Bloomberg Automation.

–With assistance from Lu Wang, Isha De, Jessica Minton, and Sophie Caronello.

Most Read from Bloomberg Businessweek

©2024 Bloomberg LP