The stock market has recently experienced a rotation of capital, with large-cap tech stocks withdrawing while small-cap stocks receiving an influx, a long-awaited move by financial experts.
According to Sam Stovall, chief investment strategist at CFRA Research, the rotation trade is unlikely to prevent a double-digit correction in the S&P 500.
Recently, stocks have experienced unusual movements, this year’s market laggards, such as small caps, have begun to outperform following cooler inflation data and dovish comments from Federal Reserve Chair Jerome Powell, which bolstered the case for a September rate cut.
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The small-cap iShares Russell 2000 ETF (NYSEARCA: IWM) has surged more than 4% this week and is up 11% this year. Conversely, mega-cap tech stocks have struggled. Nvidia (NASDAQ: NVDA), a standout performer earlier this year, has fallen 8% this week and about 15% from its recent highs.
Concerns over large-cap tech stock valuations
Stovall expresses skepticism about the sustainability of this rotation. He predicts an S&P 500 pullback in the low double digits, possibly in September. His primary concern is the overvaluation of large-cap tech stocks.
The S&P 500 is trading at a 37% premium to its average 20-year price-to-earnings ratio, while tech stocks within the index are trading at a 75% premium.
Additionally, the relative strength of the cap-weighted tech sector compared to the equal-weighted sector has reached levels not seen since 2000.
Stovall argues that the current situation is unsustainable: “There’s an awful lot of stuff going on in the large caps that say they are very expensive.”
CFRA Research’s chief investment strategist doubts that small and mid-caps can compensate if large-cap stocks decline. Large caps represent over 92% of the U.S. stock market, compared to 8% for small and mid-caps.
Stovall has recommendations for stock investors
For investors, Stovall advises caution. The most favorable scenario for the S&P 500 would involve large-cap stocks stabilizing while small- and mid-caps outperform.
However, he warns of a potential sudden downturn. Investors considering taking profits from fully valued or overvalued large-cap stocks should do so and rotate into attractive mid-and small-cap stocks or ETFs.
Stovall cautions against aggressive buying: “Don’t back up the truck. In a declining market environment, there is almost no place to hide; everything falls to varying degrees.”
Essential advice for investors should be to weather the storm, refrain from impulsive reactions, and remember that their investments will likely be profitable in the long term.
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Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
