Stock Rotation Trade Picks Up on Fed-Friendly Data: Markets Wrap

(Bloomberg) — Wall Street’s rotation into riskier corners of the stock market got another boost Friday after key economic data bolstered speculation the Federal Reserve will set up the stage next week for a rate cut in September.

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Most major groups in the S&P 500 rose on bets that the start of the policy easing cycle will keep fueling the outlook for Corporate America. Those wagers continued to drive traders into lagging areas of the bull market on hopes the rally will broaden out. Once again, smaller firms largely beat the cohort of tech megacaps — extending their July surge to about 10%.

The rotation into economically sensitive shares that suddenly took hold this month came on the heels of Fed-friendly data. Small caps are typically more sensitive to higher interest rates and economic turmoil, given their higher debt loads and weaker earnings. They do better when borrowing costs fall and the economic outlook improves.

“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. I believe there is going to be lasting power to this rotation.”

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

“The Fed can still set the table at the July meeting and serve the first cut in September,” said Tim McDonough at Key Wealth.

The S&P 500 rose almost 1%. The Russell 2000 Index climbed 1.1%. A Bloomberg gauge of the “Magnificent Seven” megacaps was flat. Treasury 10-year yields dropped five basis points to 4.19%.

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 US central bank will use the gathering to set the stage for a quarter-point cut at the following meeting in September.

“It’s been a good week for the Fed,” said Chris Larkin at E*Trade from Morgan Stanley. “The economy appears to be on solid ground, and PCE inflation essentially remained steady. But a rate cut next week remains a longshot.”

While the Fed has the data to cut rates next week, the market has already fully priced in two cuts this year already so it really doesn’t matter, according to Peter Boockvar at The Boock Report.

“The bottom line from here is whether we are going to see a rate tweaking cycle or a real rate-cutting cycle.”

To David Russell at TradeStation, the PCE number gives more evidence that we’re on the downward slope in terms of inflation.

“Investors can now focus on the big earnings next week and worry less about prices and rates because it seems the tide has finally turned,” he noted.

The rally in the biggest US technology stocks is at risk of fading further if the US 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 mega-caps this year.

In a note on Friday, 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.

Corporate Highlights:

3M Co. raised its full-year profit forecast in a sign of progress as its new chief executive officer looks to reinvigorate the iconic manufacturer after a lengthy period of turmoil.
McDonald’s Corp.’s new $5 meal deal has led to a modest increase in US visits and brought back some low-income diners — the first signs that the burger chain’s strategy to appear more affordable is paying off.
Bristol Myers Squibb Co. raised its 2024 profit forecast as demand for its new medicines suggested the company has gotten past a dip in performance.
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.

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