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Economic data has also remained remarkably resilient, even as rates remain at 23-year highs.
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CNN
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Wall Street is currently experiencing a palpable change in mood.
Strong corporate results have helped stocks hit repeated record highs in 2024, despite stubborn inflation forcing investors to lower their expectations for how many times the Fed will cut rates this year.
But slowing inflation data in recent weeks has led Wall Street to bet that the Federal Reserve will finally cut interest rates in September — and there are now more options for gains beyond just the big tech stocks that have dominated the market this year.
Data released Friday morning showed that the personal consumption expenditures price index, the Fed’s preferred gauge of inflation, slowed to 2.5% for the 12 months ended in June – another sign to optimistic investors that inflation is continuing to fall from its highest level in four decades.
The Dow Jones Industrial Average jumped 654 points, or 1.6%, on Friday, after climbing more than 800 points earlier in the day. The S&P 500 gained 1.1% and the Nasdaq Composite gained 1%.
During the week, the S&P 500 and the Nasdaq fell while the Dow posted a gain.
Economic data has also remained remarkably resilient, even as rates remain at 23-year highs. That, combined with slowing inflation, has raised hopes that the central bank can rein in prices without triggering a recession, a feat it has achieved only once since the 1990s, according to some economists. Data released Thursday showed the economy expanded at a robust 2.8% annualized pace in the second quarter, beating economists’ expectations.
Wall Street will get more clues about the Fed’s next moves at its policy meeting next week, where the central bank is expected to keep rates unchanged. While the Fed has only scheduled one rate cut this year, Traders are betting on as many as three, according to the CME FedWatch tool.
The prospect of lower interest rates is usually a positive sign for stocks, as the market tends to do better when higher interest rates aren’t weighing on corporate balance sheets. But you wouldn’t think so given the stock market rout this week.
While the market was broadly up on Friday, the S&P 500 and Nasdaq posted their worst daily performances since 2022 on Wednesday.
The reason for the drop: Investors are dumping shares of the seven largest technology companies that have dominated the market over the past two years, and their large weight has dragged down major indexes. Technology companies account for 32% of total market capitalization, the highest level since the late 1990s, according to data from MRB Partners as of June 28.
The cohort’s disappointing start to earnings season only intensified its declines: Tesla shares fell 12.3% on Wednesday after the electric vehicle maker reported a more than 40% drop in profit the night before. Alphabet shares slid 5% after beating earnings expectations but missing analysts’ expectations for YouTube ad revenue.
One sector that has recently benefited from the prospect of lower rates is small-cap stocks.
Smaller stocks tend to perform poorly when rates are high because they have more floating-rate debt than their larger counterparts. On the other hand, they tend to perform well when the Fed starts to ease its high borrowing rates.
The Russell 2000 index, which tracks the performance of small-cap stocks, has gained 10.4% since the start of the month, outperforming the S&P 500’s loss of 0.03%.
Investors are also looking at other parts of the market that could benefit from a rate cut. Stephen Lee, founder and principal of Logan Capital, said his firm added to its position in homebuilder stocks earlier this quarter, betting that slowing inflation would allow the Fed to cut rates and ease the extremely tight housing market.
Sky-high interest rates have led homeowners to delay selling their homes in order to maintain their low pandemic-era mortgage rates, even as demand has surged, pushing home prices to record highs.
Investors have worried over the past year that the market’s gains have been driven by just a handful of tech stocks, making the rally more vulnerable to pullbacks in a few stocks. The Magnificent Seven generated about 60% of the S&P 500’s total return in the first half of the year, according to Adam Turnquist, chief technical strategist at LPL Financial.
The recent surge in small caps is giving some investors hope that the market rally will continue to broaden.
There are signs that the tech stock crisis may not be over. The steep losses in tech stocks after mixed quarterly results from Alphabet and Tesla suggest investors are growing impatient with companies that are investing heavily in artificial intelligence but not seeing any revenue growth benefits.
Many big tech companies have launched AI chatbots and other flashy consumer tools since OpenAI’s ChatGPT kicked off the AI arms race two years ago, but the path to monetizing the technology remains unclear.
During Alphabet’s earnings call on Tuesday, UBS analyst Stephen Ju noted that the initial use cases for the AI models that big tech companies have invested in building “are more on the cost-saving or efficiency side.”
“When do you think we’ll start thinking about products that can help drive revenue for Fortune 500 and Fortune 1000 companies, which is probably something that can hopefully create greater value over time, rather than just reducing costs?” Ju said.
As the race for artificial intelligence continues to heat up, companies are unlikely to slow their spending in this area. But it’s unclear when those investments will improve their balance sheets.
“The risk of underinvesting is significantly greater for us than the risk of overinvesting,” Alphabet CEO Sundar Pichai said on the call.
As stocks stabilize after the trading day, levels may change slightly.