In August, amidst the turmoil of the Federal Reserve and the flood of corporate earnings reports, the U.S. stock market actually revealed a relatively clear trend that many may overlook: funds are shifting from overvalued tech stocks to cheaper small-cap stocks… The Nasdaq 100 Index, dominated by technology stocks, has underperformed the small-cap Russell 2000 Index by 540 basis points this month.
According to a report from Financial Associated Press on August 29 (editor: Xiaoxiang), amidst the turmoil of the Federal Reserve and the flood of corporate earnings reports, the U.S. stock market actually revealed a relatively clear trend that many may overlook: funds are shifting from overvalued tech stocks to cheaper small-cap stocks…
As the end of the month approaches, the core question now is whether this trend can continue.
The comparison of market performance clearly reflects this: with only one trading day left in August, the Nasdaq 100 Index has gained only 2.1% so far this month, while the Russell 2000 Index has surged by 7.5%.
This means that the Nasdaq 100 Index, dominated by technology stocks, has underperformed the Russell 2000 Index by 540 basis points this month. Stuart Kaiser, head of stock trading strategy at Citi, pointed out that this relative monthly performance of the Nasdaq 100 is in the bottom 5% of historical statistics since 1985.
In fact, if we observe the performance of ETFs, the underperformance of tech stocks is even more pronounced: this month, the Invesco QQQ ETF that tracks the Nasdaq 100 Index has barely remained flat, while the iShares Russell 2000 ETF has surged by 7%.
Is the Federal Reserve driving this thematic shift?
So, what has caused this significant divergence?
Part of the reason may simply reflect investors seeking to rebalance their concentrated and imbalanced portfolios. However, an interesting phenomenon is that the rotation and differentiation in this market trend received a significant boost following Federal Reserve Chairman Jerome Powell’s speech at Jackson Hole on August 22, when he opened the door for a potential interest rate cut the following month.
Manish Kabra, Head of U.S. Equity Strategy at Société Générale, stated that the Russell 2000 Index achieved its highest excess return relative to the S&P 500 Index on the day of Powell’s speech since November 6 of last year, when Trump won the election.
Powell’s dovish pivot is more favorable for the performance of small-cap stocks, and the logic behind this is not difficult to understand—these companies typically rely more on borrowing for growth expansion and thus benefit more from interest rate cuts.
Large corporations—especially those tech giants—often have substantial cash reserves and find it easier to access other financing channels.
It is certain that the Federal Reserve’s interest rate cuts are not only beneficial for small-cap stocks. The rise in liquidity and investor sentiment is generally expected to lift the overall market, including the ‘super tankers’ like the ‘Seven Giants.’
UBS analysts noted that past stock market bubbles have often burst due to rising interest rates, so the central bank’s resumption of a loose monetary policy cycle seems to reduce the risk of a collapse faced by overvalued tech stocks.
Nevertheless, small-cap stocks may continue to receive more support from the Federal Reserve in the short term.
Market Concerns Regarding the AI Boom
In addition to central bank policies, another catalyst driving the recent rotation in U.S. stocks may be the market’s concerns over whether AI can deliver returns commensurate with its bubble-like enthusiasm.
Undoubtedly, the current valuation of U.S. technology stocks remains significantly high compared to historical levels. UBS Group analysts believe that the rationale supporting the high valuations of technology stocks is the potential revenue generated by efficiency improvements brought about by artificial intelligence, which they estimate could reach approximately $1.5 trillion globally each year.
However, some other institutions adopt a more cautious stance. They are concerned that if such a scale of value creation fails to materialize, technology companies will struggle to absorb the capital expenditures of several trillion dollars globally over the coming years.
For this reason, NVIDIA’s earnings report became the focal point of the entire market this Wednesday. The interpretation of the performance of this global AI leader by investors will determine whether the weakness in technology stocks will continue into September.
Ultimately, although NVIDIA’s revenue, profit, and outlook remained robust, the uncertainty surrounding its Chinese business and the lackluster performance outlook still left some investors in a wait-and-see mode.
The ‘Hidden Summer’ of Small-Cap Stocks
Overall, the current momentum in the U.S. stock market may still be concentrated in small-cap stocks.
Francis Gannon, co-Chief Investment Officer and Managing Director at Royce Investment Partners, refers to this as the ‘Hidden Summer’ of small-cap stocks—amid economic uncertainty, geopolitical concerns, and daily headlines dominated by large-cap stocks reaching new highs, the recent strong performance of small-cap stocks has ‘gone largely unnoticed’.
It is worth mentioning that the Russell 2000 Index has not yet returned to its peak in November of last year, while the Nasdaq Index and the S&P 500 Index have previously set new historical highs for several consecutive weeks. This in itself may also suggest that the Russell 2000 Index has more room for a rebound…
Of course, whether small-cap stocks can initiate a new round of record-breaking performance will largely depend on the Federal Reserve’s actions.
From the financial calendar perspective, investors may need to focus on three major macro events next month: the August non-farm payroll report to be released on September 5, the August CPI inflation data to be announced on September 11, and the Federal Reserve’s policy decision on September 17.
In light of the strong performance of small-cap stocks in this late summer period, it is worth watching whether the upcoming golden autumn will see a similar rotation phenomenon in U.S. stocks, shifting from ‘big and beautiful’ to ‘small and strong,’ and if this trend can continue further.
编辑/wendey
