Benign U.S. Inflation Could Support Stock Market Laggards
The recent update on U.S. inflation has sparked optimism among investors, hinting at a potential shift in the Federal Reserve’s interest rate policy. This shift is seen as a beacon of hope for various sectors of the stock market that have been overshadowed by the dominant Big Tech rally.
With consumer price data suggesting a more benign inflationary environment, the anticipation for rate cuts in the near future has intensified. Such expectations were bolstered on Wednesday, leading the S&P 500 to reach new heights as the market eagerly anticipated remarks from Fed Chairman Jerome Powell at the end of the central bank’s meeting.
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This environment of cooling inflation and the prospect of a looser monetary policy is seen as particularly beneficial for segments of the market that have suffered due to heightened interest rates. Notably, small caps and financial companies might see a reprieve, enhancing the diversity of the current market rally that has been narrowly focused on a handful of tech giants.
Market indicators now suggest a more than 70% likelihood of a rate cut by September, a significant increase from earlier predictions. Despite the S&P 500’s approximate 14% gain this year, a substantive portion of this growth is attributable to just six companies – Nvidia, Microsoft, Apple, Meta Platforms, Alphabet, and Amazon.com. These companies have disproportionately influenced the index’s performance, according to S&P Dow Jones Indices.
If the recent CPI report is the beginning of a trend towards more favorable economic data, there could be a comprehensive lowering of yields, which would aid sectors like small caps and others that are sensitive to yield increases, such as financials and industrials. These sectors have lagged behind as technology and growth stocks have primarily propelled stock index gains in recent times. However, they have shown potential for significant gains when monetary policy eases.
For example, in the latter part of 2023, small caps experienced a surge on the expectation that the Fed would halt rate cuts, with the Russell 2000 climbing 13.6% in the last quarter, outpacing the S&P 500’s 11.2% gain.
“The Fed doesn’t even need to cut rates in July; it just needs to be on the path towards starting the rate cut cycle. This should contribute to a broader market performance,” stated Luke Tilley, Chief Economist at Wilmington Trust. He emphasized the expectation for a more broadly distributed market rally.
Indeed, Wednesday’s trading session displayed signs of a diversifying market. While tech giants like Apple and Nvidia saw significant gains, the Russell 2000 also rose by 2.6%, compared to a 1.1% increase in the S&P 500. Additionally, sectors such as banks within the S&P 500 and transportation stocks witnessed upticks, albeit they have experienced declines on the year.
The equal-weight S&P 500 also saw an increase, suggesting a more evenly distributed market gain than has been observed so far this year. Despite investors continuing to favor the year’s successful tech stocks, there are unmistakable signs of a broadening market, offering a chance for previously lagging sectors to participate in the rally.
As investors process the implications of a potential shift in monetary policy, the broader market may indeed offer more opportunities for growth, moving beyond the dominance of a few tech behemoths. The hope for rate cuts seems to not only have lifted the spirits of the market but could also signal a more inclusive growth trajectory for the remainder of the year.
