A ‘great equity rotation’ that has been expected by many markets experts may finally arrive soon, according to Wisdomtree’s Pierre Debru.
In his latest market commentary, the firm’s head of quantitative research and multi-asset solutions considered the prospect of some of the money made in tech stocks such as the magnificent seven being shifted into other assets such as small caps.
“For a while, it felt like nothing could stop their march forward, and they would defy gravity for years to come,” he said. “But in markets, like in life, nothing is forever.
“On 10 July, the magnificent seven may finally have met a worthy opponent in the form of a strong CPI print. Since the Bureau of Labor Statistics published a lower-than-expected CPI at +3% year-on-year and core CPI at 3.3%, markets appear to have finally pivoted,” he continued. “In the space of a week, the Russell 2000 jumped 9.2% while the Nasdaq lost -4.2%. In the same period, the S&P 500 equal weight outperformed the S&P 500 by 4.3%.”
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Debru added this rotation away from the magnificent seven and towards smaller caps, while impossible to predict in terms of the timing or magnitude, has been a long time coming.
“We believe a few catalysts may be aligning, leading to the establishment of a wider and longer trend in which the market broadens, the remaining 493 stocks in the S&P 500 as well as small caps rebound and play catch-up with the magnificent seven.”
He noted the Federal Reserve moving towards its first interest rate cut in September could be particular beneficial to smaller companies and therefore further encourage this kind of rotation.
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Another tailwind to this may come in the form of the gap in earnings growth expectations between the magnificent seven and the rest of the market closing significantly towards the end of the year.
“While the magnificent seven exhibited much higher earnings growth in 2023 and the first half of 2024, the rest of the market is catching up,” Debru said. “Q4 2024 and 2025’s estimates are broadly similar across the two groups. This should create opportunities for stocks outside those seven mega caps to capture investors’ attention and catch up.”
A third potential catalyst for rotation towards the end of the year in Debru’s view is the November election.
“The US presidential election creates significant uncertainty that tends to weigh on markets,” he said. “Historically, once the election’s results are known, uncertainty lifts, which very often creates a late-year small-cap rally.”
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