August has not gotten off to a good start, as stocks plummeted on Monday.
July was an interesting month for U.S. stocks, as there was a marked shift away from tech stocks toward small caps.
Tech stocks, as measured by the Nasdaq 100, were down about 2% in July, while small cap stocks, as measured by the Russell 2000, soared 10% in the month. The S&P 500 rose 1.1%, which is roughly in line with the average historical return for the index in July.
While tech stocks and small caps stocks were headed in different directions, their movements were largely fueled by same factor — the great rotation.
The great rotation
Investors may have seen this term emerge recently in headlines in financial media and wondered what it meant. Quite simply, it is a broadening of the market beyond the mega cap growth stocks, which have dominated the past two years, into small caps, mid caps, and value stocks.
Many experts had predicted this to happen this year, as the mega caps, mainly technology and AI stocks, had become overheated, with their valuations soaring to unsustainable levels. Much of the growth was fueled by the AI boom and strong earnings, but it caused a bit of a feeding frenzy as more and more investors piled in, looking to capitalize on the higher returns.
Many analysts thought the broadening of the market would take place earlier this year, as we saw small caps outperform large caps in the fourth quarter of last year after getting trounced all year. But the trend did not stick, as large caps continued their dominance through the first half of the year.
That led to soaring valuations that became unsustainable, even with strong earnings reports. As a result, the large cap tech and growth stocks have come back to earth a bit.
Magnificent Seven struggle in July
Among the Magnificent Seven stocks, five of them were down in July, by quite a bit. Alphabet (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT), and Meta (NASDAQ:META) were all down about 6% in the month while NVIDIA (NASDAQ:NVDA) fell 5% and Amazon (NASDAQ:AMZN) dropped 3%. Only Tesla (NASDAQ:TSLA), which had been a laggard, and Apple (NASDAQ:AAPL), which had underperformed, were up last month.
Can tech stocks bounce back in August?
July is typically a strong month for markets as it is the month when most of the major companies report earnings for the quarter ended June 30.
August, on the other hand, is one of the worst months for stocks. Historically, the S&P 500 has been flat in August. It is one of only four months that have historically had flat or negative returns.
One reason is it’s the second month of earnings season, and most of the big companies have already reported earnings. Also, the economy typically slows, as people are on vacation, and trading slows with it.
But this August seems a bit different, as there are signs of a slowing economy and renewed fears of a recession, due perhaps to higher interest rates finally taking their toll on growth. Last week, the unemployment rate rose as fewer jobs were created than expected. Also, the manufacturing index came in lower than expected.
Will the correction continue?
The correction in tech stocks was overdue, so this should not be a shock. However, without any major catalysts in August, and many large caps still overvalued, don’t expect things to bounce back too quickly.
The one thing this correction does is improve the chances of not only a rate cut in September, but perhaps even a 50-point rate cut, and perhaps multiple cuts before the end of the year.
A turnaround in August doesn’t seem likely, as the market is still correcting course. But keep an eye out for opportunities in September and Q4 when rates likely begin to come down.