(Bloomberg) — Wall Street traders renewed expectations for a half-percentage-point interest-rate cut by the Federal Reserve next week, spurring trading in stocks that would benefit most from policy easing.
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Economically sensitive stocks outperformed the tech giants that led the bull market rally, with the Russell 2000 index of smaller companies up 2%. An equally weighted version of the S&P 500 — in which companies like Nvidia Corp. carry the same weighting as Dollar Tree Inc. — outperformed the benchmark U.S. stock index. That measure is less sensitive to gains from the largest companies — offering a glimmer of hope that the rally could broaden.
As the S&P 500 surged from record high to record high in the first half of the year, some investors began to worry that only a handful of players outside of the tech giants were participating in the rally. Now, corners of the market outside of Big Tech are rallying as investors grow more confident that the start of the Federal Reserve’s rate-cutting cycle will continue to fuel corporate America.
“The biggest news of the past 24 hours has been the shift in the odds of a 50bp rate cut at next week’s Fed meeting,” said Jonathan Krinsky of BTIG. “Small-cap companies offer better risk-reward in the near term, and we think large-cap tech companies are likely to see another reprieve, although they will certainly participate if the S&P 500 hits new highs.”
The S&P 500 rose 0.6%, while the Nasdaq 100 gained 0.4%. The Dow Jones Industrial Average advanced 0.8%. The yield on the 2-year Treasury note fell four basis points to 3.6%. The dollar fell. Gold hit another record high.
Cantor Fitzgerald’s Eric Johnston says that while the consensus is that the Fed will cut rates by 25 basis points next week, there is “of course” a chance that officials will decide to raise rates.
Small-cap companies, in particular, are believed to see a “huge uptick” if the central bank chooses to cut interest rates by 50 basis points — and will continue to rise with a “very accommodative 25 basis points.”
Valuation still looks favourable to small-cap companies, and performance has done little to move that trend, according to Simon Heymann of ProShares.
“The expected Fed rate cut this month could be the catalyst for this valuation-driven opportunity,” he said. “Interest rate sensitivity in small-cap companies is one of the most widely accepted investment principles, and the Fed rate cut cycle could provide an additional boost to small-caps this time around.”
Hyman noted that the price sensitivity of small-cap stocks is largely due to the group’s greater leverage versus larger companies – smaller companies typically have to borrow more money.
“That’s clearly true today, with the Russell 2000’s leverage ratio being three times that of the S&P 500,” he says. “By itself, that difference is more than enough to suggest that small-cap companies are the biggest beneficiaries of lower interest rates, where debt relief is typically most impactful.”
“While cracks are developing in several long-time growth leaders, the overall technical picture still shows broader fundamental participation than typically accompanies a cyclical peak,” said Doug Ramsey of The Leuthold Group. “We continue to view this expansion as more likely a sign of a leadership change (from growth to value) than a harbinger of another rally in the blue-chip averages.”
While there has been a broader rotation below the surface of the market away from technology and telecoms toward more defensive corners, the one issue is that earnings growth at the top end of the market is still expected to outpace the rest of the index, according to Ryan Grabinski of Strategas Securities.
“If growth becomes scarce and investors flock to growth, I wouldn’t be surprised to see the most liquid names rally again,” Grabinski said. “They certainly face legal and regulatory challenges, but to be fair, this is nothing new. Overvaluing the ‘big seven’ can be a big risk to your portfolio.”
In short, with the expected growth of Mag Seven, this makes it “hard to fade away,” he concluded.
Fed Countdown:
Yes, it’s a tough ride, but I believe the Fed will cut rates by 50 basis points at its next meeting. The argument for more action up front is strong.
A common reason for not reaching 50 is the message it sends. “The Fed must know something that everyone else doesn’t,” or so some people think. I don’t believe that for a moment.
The risks to the market are that the Fed cuts rates by only 25 basis points, especially given the unlikely threshold of “soft-cutting.” So the “how the market responds” argument doesn’t seem convincing. I think markets would welcome such a move.
While we have put next week’s 50 basis point rate cut on the back burner, talk of a 50 basis point rate cut has risen from the dead.
While we originally called for a 50 basis point rate cut — and we think a 50 basis point rate cut is the right thing to do — we can’t see this Fed, which is so regressive, going to 50 basis points. The consensus view from Jerome Powell is that he won’t get enough votes to get 50 basis points. So his strategy will be to cut rates by 25 basis points and then be very dovish at the press conference. That’s what we think, not what we want.
Given the price action, investors are certainly looking for a dovish rate decision. This could come in the form of a surprise 50bp cut — or a 25bp cut, with a strong hint of at least a 50bp cut in the remaining two meetings later this year.
It’s all about economic growth and the labor market. One might think that the probability of a 50 basis point rate cut had dropped to zero after the hottest inflation data. In fact, the probability dropped to near zero, but it has since rebounded, and we are back where we started. That means there is an even chance of a 25- or 50-basis point rate cut next week.
And here’s the thing: Now that the market is back to pricing in big odds at the 50 basis point level like a 25 basis point cut at the gates, anything other than the 50 basis point level will disappoint the market.
We maintain that a quarter-point rate cut is the path of least resistance, although a 50-bp rate cut is clearly on the table and will be part of the Fed’s discussions. We recognize that the CPI and PPI are likely to translate into a more benign move in core CPI. As the Fed’s preferred measure, the overall inflation profile will appear less worrisome to policymakers, thus allowing the FOMC to focus on the labor market.
A 25-50bp cut may be sooner than most people expect. In our view, the dot chart will be the most prominent part of next week’s Fed guidance, along with Chairman Jerome Powell’s post-meeting press conference. We expect future Fed guidance to be broadly dovish.
Treasuries will be looking at the size of the cut, the dot plot, and Powell’s comments as key indicators. Given our expectation that the Fed will send a generally dovish tone with a 25bp rate cut to start the cycle, rates could continue to rise and the upside curve could continue to rise. We prefer to buy dips in duration.
The company’s most prominent achievements:
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Adobe Inc. delivered a forecast that failed to quell investor impatience for new AI tools to start generating cash.
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Oracle Corp. said its annual revenue will rise to at least $104 billion in fiscal 2029, an upbeat signal about the software maker’s growth prospects for its cloud infrastructure business. Shares of the company jumped to record highs.
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Boeing Co. factory workers have walked off the job for the first time in 16 years, halting manufacturing at the planemaker’s Seattle hub after members of its largest union voted overwhelmingly to reject a contract offer and strike.
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RBC Capital Markets downgraded energy company Halliburton Co. from outperform to sector perform.
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Furniture retailer RH reported second-quarter revenue and earnings that beat Wall Street expectations. The company reported improved customer demand in recent months, though it lowered its sales forecast for the year, saying revenue would lag demand as it reshuffles its product lineup.
Some key movements in the markets:
Stocks
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The S&P 500 was up 0.6% as of 11:26 a.m. New York time.
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The Nasdaq 100 rose 0.4%.
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The Dow Jones Industrial Average rose 0.8%.
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The Stoxx Europe 600 index rose 0.7%.
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MSCI World Index rose 0.7%
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The Bloomberg Magnificent 7 Total Return Index rose 0.4%.
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The Russell 2000 index rose 2%.
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The S&P 500 Equal Weighted Index rose 1%.
Currencies
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The Bloomberg Dollar Index fell 0.4%.
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The euro rose 0.1% to $1.1088.
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The pound rose 0.1% to $1.3143.
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The Japanese yen rose 1% to 140.38 yen per dollar.
Cryptocurrencies
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Bitcoin rose 1.3% to $58,931.88
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Ether price rose 1.5% to $2,386.03
Bonds
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The yield on the 10-year US Treasury note fell 2 basis points to 3.66%.
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The yield on the 10-year German bond was little changed at 2.15%.
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The yield on the 10-year British bond fell one basis point to 3.77%.
Goods
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West Texas Intermediate crude rose 1% to $69.65 a barrel.
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Spot gold rose 0.8 percent to $2,577.57 an ounce.
This story was produced with the help of Bloomberg Automation.
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