By Saqib Iqbal Ahmed and Louis Krauskopf
NEW YORK (Reuters) – Signs of slowing U.S. inflation on Wednesday and rising hopes of an interest rate cut from the Federal Reserve could be a positive signal for much of the struggling stock market, driven by a rally led by big technology companies.
The S&P 500 hit a new high after a strong consumer price index boosted expectations that the Fed will cut interest rates in the coming months. Stocks held on to gains after the Fed kept interest rates on hold and Fed Chairman Jerome Powell gave an upbeat assessment of the economy.
Some investors believe hopes of lower inflation and easier monetary policy could bolster sectors of the market such as small caps and financials that have been hit by rising interest rates, which could ease concerns about the risk of a market rally concentrated in the Big Tech cohort.
The S&P 500 is up about 14% this year, but about 60% of that return has been driven by six companies whose stocks make up the largest weightings in the index: Nvidia, Microsoft, Apple, Meta Platforms, Alphabet and Amazon.com, according to data from S&P Dow Jones Indices.
Angelo Kourkafas, senior investment strategist at Edward Jones, said if Wednesday’s Consumer Price Index (CPI) report is the start of improving data that makes a rate cut more likely, “it could push the entire yield curve lower, benefiting some sectors that have been sensitive to rising yields,” including small caps and cyclical stocks such as financials and industrials.
Short-term interest rate futures are currently pricing in a more than 70% chance of a rate cut by September, slightly better than a coin toss earlier in the day, but are now rising.
In recent years, technology and growth stocks have driven up stock price indexes, but interest rate-sensitive stocks have often surged when expectations of monetary easing have risen.
One such episode came in the final months of last year, when small-cap stocks surged on hopes that the Fed was done cutting interest rates.The small-cap-heavy Russell 2000 index rose 13.6% in the fourth quarter of 2023, compared with an 11.2% gain for the S&P 500.
“The Fed doesn’t even need to cut rates in July like we expect; they just need to head into a rate-cutting cycle, so to speak, which should help support performance gains,” said Luke Tilley, chief economist at Wilmington Trust.
“Our view is not only that there is room for expansion, but that we fully expect it,” he said.
Some expansion was evident on Wednesday: Market-leading stocks such as Apple Inc. and Nvidia Corp. surged, while the small-cap-heavy Russell 2000 index rose about 2.2%, compared with a 1.1% gain for the S&P 500. The small-cap index was down 0.1% for the year to date as of Wednesday’s release.
Other sectors that rebounded on Wednesday included the S&P 500 bank index, which rose 0.6% but remained in negative territory for the quarter. The Dow Jones Transportation Average was up 0.9% on the day, and the S&P 500 real estate index was up 1.1%, though both groups are still down year to date.
The equally-weighted S&P 500, a proxy for the index’s average stocks, rose 0.7% and is up just 4.5% this year.
To be sure, investors also held on to some of this year’s winners: Technology stocks, the best-performing stocks in the S&P 500 this year, rose 2.9% on the day, with Nvidia and Apple each up more than 4%.
At the same time, investors are likely to be more cautious about cutting tech bets and investing in other market sectors. The tech-heavy Nasdaq 100 Index has outperformed the Russell 2000 Index by about 24 percentage points over the past year. Looking back further, the performance gap is even wider: 50 percentage points over two years and 53 percentage points over five years, according to LSEG data.
(Reporting by Saqib Iqbal Ahmed and Louis Krauskopf; Editing by Ila Iosebashvili and David Gregorio)
