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The sell-off in the tech-heavy Nasdaq and semiconductor stocks has caused a notable shift in investor interest from large tech companies to smaller firms and various sectors. The Russell 2000 small-cap index has surged by an impressive 7 percent since last Thursday, supported by a more optimistic earnings forecast. Interestingly, the famed “Magnificent Seven”—the heavily-weighted stocks that propelled the S&P 500 forward over the past year—have seen a downturn.
These declines were exacerbated by a worldwide sell-off in semiconductor companies.
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Conversely, stocks in financial services, energy, and real estate sectors have shown strong performance, helping to push most other S&P 500 stocks higher. “Suddenly, we have a wider array of options, whereas last year the options were quite limited,” noted Jurrien Timmer, Director of Global Macro at Fidelity.
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“When there’s a more widespread recovery in earnings along with a change in Fed policy, and the bond market is stable, other investment opportunities become available,” he stated.
The S&P 500 index rose by 14 percent in the first half of 2024, although this was primarily driven by a select group of large firms, creating concerns regarding the sustainability of the rally. For active fund managers, relying on a limited number of outperforming stocks has made it challenging to keep pace with benchmarks. Last week’s inflation figures bolstered investor anticipation of a Federal Reserve interest rate reduction in September.
Smaller firms within the Russell 2000, often carrying larger debt loads, have particularly gained from this shift in market sentiment. The gains observed over the past week have been widespread, as more than 1,500 of approximately 2,000 companies in the Russell index have risen. The equal-weighted S&P 500 outperformed its capitalization-weighted counterpart by nearly 3 percent, while the latter declined.
Small-cap stocks gaining traction
Experts at Bank of America have noted that short covering has been a significant factor driving the Russell 2000’s rally, with heavily shorted stocks performing strongly. “Many people were caught off guard,” remarked Brandon Nelson, a portfolio manager at Calamos specializing in small- and mid-cap stocks.
“While the Magnificent Seven and AI-related stocks still hold growth potential, their earnings growth compared to the broader market might diminish,” commented Jim Tierney from AllianceBernstein. While many investors had looked forward to a broader distribution of gains, there are apprehensions regarding the overall index’s performance. The S&P 500 index dipped by 1.5 percent even with over 350 stocks gaining during the week following the inflation data release, primarily due to the substantial influence of the largest tech stocks.
It remains uncertain if the market can maintain its upward momentum. Investors are closely monitoring to see if fresh capital flows into stocks beyond the Magnificent Seven, or if this rotation is merely internal. Many analysts have highlighted the fragile situation that smaller companies find themselves in to maintain their upward trend.
They need the Fed to lower rates without instigating an economic slowdown that could negatively impact profits. For instance, Thursday’s data indicating jobless claims at their highest since 2021 led to a 1.9 percent drop in the Russell 2000 index. Despite the recent increases, small-caps and the equal-weighted S&P 500 remain behind the benchmark S&P 500.
“You’ve made some progress in closing the gap recently,” stated Nelson at Calamos, “But you can’t reverse years of underperformance in just five days.”
