S&P 500’s Equal-Weighted Index Hits All-Time High: Markets Wrap

(Bloomberg) -- Wall Street traders gearing up for this week’s Federal Reserve decision kept driving a rotation out of the tech megacaps that have powered the bull market in stocks.

As bets on a half-point Fed cut on Wednesday kept growing, money continued to flow into economically sensitive corners of the market. While the S&P 500 edged only mildly higher — most of its shares were up. The gauge’s equal-weighted version — one that gives Target Corp. as much clout as Microsoft Corp. — hit a record high on hopes the rally will broaden out.

“We remain positive on equities,” said John Stoltzfus at Oppenheimer Asset Management. “The broad rotation which began in the rally from last year’s S&P 500 low has deflected volatility repeatedly. Pullbacks experienced thus far this year have mostly looked like ‘trims’ and ‘haircuts’ for the S&P 500.”

In the run-up to the Fed decision, strategists from Morgan Stanley to Goldman Sachs Group Inc. and JPMorgan Chase & Co. are saying that the size of the reduction is less relevant for stocks than the health of the US economy.

“We’re getting a rate cut of some sort this week absent an act of God,” said Callie Cox at Ritholtz Wealth Management. “The economic impact of one rate cut – regardless of whether it’s 25 or 50 basis points – will likely be insignificant. The path and degree of cuts over the next year or so matters the most.”

The S&P 500 rose 0.1%. Its equal-weighted version added 0.7%. The Nasdaq 100 slid 0.5%. The Dow Jones Industrial Average gained 0.6%. The Bloomberg “Magnificent Seven” gauge of megacaps slipped 0.7%. The Russell 2000 of small firms added 0.3%. 

Banks outperformed the broader market on bets a soft economic landing would trump margin pressures. Apple Inc. led losses in big tech as a closely followed analyst warned demand for the iPhone 16 Pro has been lower than expected.

Treasury 10-year yields declined three basis points to 3.62%. The dollar fell to the lowest since January. Gold hit an all-time high.

Technology giants like Nvidia Corp. and Microsoft Corp. have led gains in equities for much of the last two years, with investors attracted to their booming profits and exposure to artificial intelligence. 

However, since the S&P 500 peaked on July 16, the so-called Magnificent Seven have mostly slumped, with the cohort of tech megacaps falling over 6%. Meantime, other industries have gained traction.

“Since technology stocks (temporarily?) peaked in July, the winners have been the remaining ‘493 stocks’ in the S&P 500,” said Paul Nolte at Murphy & Sylvest Wealth Management. “There have been plenty of ‘false starts’ when technology stocks seem to be done, only to see them regain a market-leadership position.”

Nolte says that over the past three to six months, the spread between the high flying technology sector and the average stock was large as early 2000. 

“While history may not repeat itself, it would at least argue to reduce exposure to the tech sector for a while,” he concluded.

Meantime, hedge funds are back to buying big technology stocks, according to a recent Morgan Stanley’s prime brokerage report. Conversely, defensive sectors have been net sold as the funds trimmed their exposure across real estate, health care and utilities.

As investors prepare for the start of the Fed rate-cutting cycle, stocks and bonds both appear to be priced aggressively, yet to embrace different views of the forward path, according to Lisa Shalett at Morgan Stanley Wealth Management.

“Equities are pricing an ‘immaculate soft landing,’ driven by double-digit profit growth without major disruption to the labor market and consumption,” she noted. “Bonds, for their part, have rallied aggressively, suggesting recession and intimating that the Fed is ‘behind the curve’.”

If bonds are “right,” stocks face downside from falling earnings, Shalett said. If they are “wrong,” rates will back up, creating headwinds for valuations.

“Consider owning the equal-weighted S&P 500 Index as better risk-adjusted exposure than the market-cap-weighted version,” she said.  “Financials, industrials, energy, health care, infrastructure-linked stocks and materials continue to offer compelling ideas, as do parts of the tech sector, such as software. Look for defensive ideas among residential REITs and utilities.”

The upside for stock valuations is likely limited from current levels, as the outlook for economic growth is a more important driver than the speed of rate cuts alone, according to Goldman Sachs Group Inc. strategists led by David Kostin.

“While some investors believe the speed of Fed cuts will be the key determinant of equity returns in coming months, the trajectory of growth is ultimately the most important driver for stocks,” they wrote.

Liquidity and the state of the economy will define the equity market reaction to rate cuts, according to JPMorgan Chase & Co. strategists led by Mislav Matejka. They recommend staying overweight defensives and expect small caps to benefit from continued decrease in bond yields.

“If the labor data weaken from here, markets can trade with a risk-off tone regardless of whether the Fed’s first move is 25 or 50 basis points,” Morgan Stanley’s Mike Wilson noted. On the other hand, if jobs were to strengthen, a series of 25 basis-point reductions into mid-2025 could prop up equity valuations further, he said.

The election, the economy, just how big this week’s US interest rate cut will be — it has all left the market on edge. Savita Subramanian, an equity and quant strategist at Bank of America Corp., wants investors to avoid risks. 

“You want to be in safe dividends — and I know this is the most boring call of all time, but sometimes boring is good,” Subramanian said in an interview with Bloomberg Television on Monday.

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