Stock Rotation Finally Holds as Wall Street Chases New Leaders

097sw1e9aj0)ovjpanjvqzce_media_dl_1.png Bloomberg

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(Bloomberg) — For most of last year, investors were warned that hiding out in Big Tech was becoming a dangerous move. Turned out that wasn’t great advice.

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Up until November, the Magnificent Seven technology giants, including Nvidia Corp, Microsoft Corp. and Amazon.com Inc., accounted for most of the market’s double-digit advance. Since then, though? It’s been a different story.

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The long-forecast rotation from tech is set to enter its fourth month, and few on Wall Street expect it to end. A version of the S&P 500 Index stripped of market-cap bias has jumped 6% since early November while the standard version has added just 1.6%. Materials, health care and consumer sectors have supplanted tech at the forefront. Small caps in the Russell 2000 Index have soared more than 7%. The Invesco S&P 500 Equal Weight exchange-traded fund (RSP) has taken in $4.8 billion this year through Friday, the third-most among about 1,500 US equity-focused ETFs.

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Optimism that the American economy is set to take off has fueled the rotation, with companies whose fortunes are closely tied to the business cycle attracting investor cash. At the same time, artificial intelligence investing has become less monolithic in the tech sector, with investors starting to choose winners and losers.

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“Street expectations for the next few years suggest that whether due to fiscal policy changes, monetary policy changes, the long-awaited industrial cycle or a mixture of all three, growth is set to broaden out considerably,” said Andrew Greenebaum, senior vice president of equity research product management at Jefferies LLC.

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The optimism is not without risks. The labor market remains cool, geopolitical tensions have heightened and domestic unrest may lead to another government shutdown. And, of course, calls for tech’s demise have failed to materialize for years now.

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Still, there are signs of measurable improvement in market breadth and earnings growth expanding into erstwhile laggards. Big Tech profit gains that have long outstripped the rest of the S&P 500 are set to narrow at the same time investors are becoming more concerned about massive tech capital outlays.

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“Tech sector and Magnificent Seven leadership have stalled since the end of October, with investors embracing the call for broadening earnings growth,” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, said in a Jan. 26 note to clients. “Consider preparing for new equity index leadership.” 

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Greenebaum points to three areas in the market when conveying the “realness” of the rotation to clients. The first is the Russell 2000’s outperformance compared to large caps at the same time cyclicals in the S&P 500 have taken up the mantle from tech. Investment flows into small caps have “improved considerably” over the last several months, he said. Finally, he expects small caps to deliver a bigger rate of earnings growth.