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Volume 13, Edition 17 | July 13 - July 19, 2024

Rotations: What Comes Around Goes Around

Doug Walters, CFA
The market rotated this past week favoring smaller and cheaper companies. Investors are pondering how best to react to this latest move.

Contributed by Doug Walters, David Lemire, , Max Berkovich

The market is rotating. You’ve heard this term, I’m sure. In fact, we’ve used it in our Headline of the Week section below. But what does it mean? Is there something we need to be doing as investors? Is rotation good or bad? We will tackle it all today.

Market rotation is simply a notable shift in which types of investments are performing well and which are lagging. It could be Small versus Large, Value versus Growth, Stocks versus Bonds, or Industrials versus Technology. Anything. Recently, we’ve seen a shift from US Large-Cap stocks to Small-Cap and Value stocks.

The Fed Pulling the Strings

This week’s shift may prove lasting or fleeting. It is too soon to tell. However, it appears to be driven by the Federal Reserve’s commentary, which has investors expecting a rate cut sooner rather than later. When the Federal Reserve cuts interest rates, it lowers the cost of borrowing money, potentially benefiting Small-Cap and Value stocks to a greater degree.

React With Evidence, Not Emotion

So, what should investors do? Investors might suffer from the fear of missing out (FOMO) if they don’t benefit from the rotation, or they could become overconfident, believing that they can market time rotations. Neither will lead to good results other than through luck. As evidence-based investors, we always make decisions based on what we know today, not what we think will happen tomorrow. As such, a rotation will not impact our choices except to the extent that market moves make specific market segments more attractive (for example, by becoming cheaper).

Build Your Rotation Defenses

If you are looking for protection against a market rotation, a well-diversified portfolio packed with factor-based investments is a good start. Maintaining a long-term perspective will also help. Focus on your investment goals and ensure your portfolio matches your risk tolerance and financial objectives. If you do that, you are already ahead of the game.

4.6%

Outperformance of Value versus Growth

The rotation this week was sharp between Value and Growth. The Russell 1000 Value Index outperformed the Russell 1000 Growth Index by 4.6% for the week.

Headline of the Week

Rotating to Cuts?

A bit of a continuation of last week’s comments, but markets have been aggressively pricing in at least one interest rate cut. While the Fed is talking down chances of a July cut, September seems almost a foregone conclusion (barring an inflation shock). Thus, a rotation has begun as money has shifted from mega-cap tech stocks into those areas that stand to benefit from lower rates, namely small cap and value. We have seen previous attempts to rotate out of tech and invest based on hopes for rate cuts; whether this time proves different remains to be seen. Weakness in the employment picture seems to offer a more rational thesis for cuts, but again, we shall see.

The Week Ahead

The week brings earnings reports, a Gross Domestic Product (GDP) for the 2nd quarter, and a major inflation report right before the Federal Reserve makes a rate decision the following week.

PCE of Mind

The preferred inflation measure for the central bank comes out on Friday when the Personal Consumption Expenditure (PCE) is unveiled.

  • While expectations are that monthly prices moved up 0.1%, which is not as nice as the flat report for May, the annual number is expected to decline to 2.5%.
  • If we continue to demonstrate progress on bringing down inflation, the market will continue to push up the odds for rate cuts.
  • The Consumer Price Index, the other major inflation report, released earlier in the month showed cooling inflation and cemented market expectations for a rate cut in September, which also fueled the most recent run-up in stocks.

Now is the Time

The preliminary GDP release on Thursday is expected to show an expansion in the economy for the second quarter of roughly 2%.

  • The two central bank GDP trackers have created a very wide gap. The Atlanta Fed’s GDPNow model suggests the economy expanded 2.4% for the quarter, while the New York Fed’s Nowcast model only predicts a modest 1.8% expansion.
  • The data isn’t expected to be market-moving unless the number comes in below 2%, and with several revisions still coming, this read isn’t as important to the rate setter as the inflation print.

Place Your Bets!

Earning season is in full force, with several big names reporting next week. However, Tuesday is the big day.

  • Tuesday’s earnings calendar has Visa (V), Coca-Cola (KO), Tesla (TSLA), and Alphabet (GOOG, GOOGL) on the docket.
  • Tesla’s stock price has rebounded by more than a third over the past month, with expectations for lower gross margins and significantly lower earnings per share than a year ago, investors are betting on better results in the future.
  • Alphabet, on the other hand, is expected to post earnings that are 27.6% higher than a year ago but will most likely be overshadowed by Tesla’s results, be they what they may!

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