Big Tech Shares Lose Ground as Investors Pivot to Small-Cap Stocks

Big Tech stocks, once the primary drivers of market rallies, are losing their appeal as investors shift their focus to smaller companies and other previously overlooked sectors. The Russell 2000 small-cap index has surged by 7% since last Thursday, marking a significant market shift influenced by falling inflation and an improved earnings outlook.

This rotation away from megacap tech stocks, known as the Magnificent Seven, has led to a broad-based rise in other sectors, including financials, energy, and real estate. These gains come despite a global sell-off in semiconductor companies, which has affected tech-heavy indexes like the Nasdaq.

Jurrien Timmer, director of global macro at Fidelity, noted, "All of a sudden we have a larger menu to choose from, whereas last year there was really only one thing on the menu. When you have a more broad-based earnings recovery and a Fed pivot at the same time, there are other things to buy now too."

The S&P 500 advanced 14% in the first half of 2024, but its reliance on a few large companies raised concerns about the rally's fragility. Last week's inflation data solidified investor hopes of an interest rate cut by the Federal Reserve in September. This shift particularly benefits smaller companies in the Russell 2000, which tend to have higher debt burdens.

Despite the broader market gains, some investors remain cautious. Brandon Nelson, a portfolio manager at Calamos, pointed out, "There was some complacency with people parked in the megacaps and ignoring or even shorting small-caps because that had been the right pair trade for so long."

While megacap tech stocks like Nvidia have seen significant losses recently, analysts like Jim Tierney of AllianceBernstein believe that the underlying growth trends in artificial intelligence and other sectors remain strong, although their dominance may diminish.

The future of the S&P 500's performance will depend on whether new investment money flows into other stocks or if it's merely an internal rotation away from the Magnificent Seven. Timmer highlighted the delicate balance required for smaller companies to continue rising: they need the Fed to cut rates without triggering a major economic downturn.

Even with recent gains, small-caps and the equal-weighted S&P 500 are still lagging behind the benchmark S&P 500. As Nelson from Calamos cautioned, "You’ve closed the gap a little bit in the last week, but you can’t undo years of underperformance in five days."