US Stock Rally Expands as Investors Eye Fed's Next Move

An expanding US stock rally is handing investors a reassuring harbinger of the market's overdependence on technology shares, with attention centered on key jobs data and the Federal Reserve's forthcoming interest-rate decisions.

Major technology stocks like Nvidia and Apple have been responsible for a good amount of the market's gains this year, but investors are starting to take more interest in value stocks and small caps that will benefit from expected rate cuts from the Federal Reserve. The central bank is expected to start a rate-cutting cycle at its Sept. 17-18 monetary policy meeting.

The broadening of the rally, which gained momentum last month before hitting a skid during an early August sell-off, is seen by many as a healthy development. Until recently, the market's rally had been dominated by just a handful of technology giants, with Nvidia alone accounting for nearly a quarter of the S&P 500's 18.4 per cent year-to-date gain on the back of investor enthusiasm for artificial intelligence.

"No matter how you slice it, you've seen a significant broadening out of the market, and I believe it has staying power," said Liz Ann Sonders, Chief Investment Officer at Charles Schwab.

Value stocks also include financials and industrials sectors that sometimes trade at low valuations compared to their peers based on a range of metrics that include book value or price-to-earnings ratios. Some investors say these are likely to move higher, along with small-cap stocks, if the Fed cuts while its view of the economy stays optimistic.

That market rotation is accelerating, recent data shows. Whereas just 14% of S&P 500 stocks outperformed the index during the past year, over the last month that number widened to 61%, according to Charles Schwab.

The so-called "Magnificent Seven" group of technology giants, which also includes Nvidia, Tesla, and Microsoft, has lagged the other 493 stocks in the S&P 500 by 14 percentage points since a weaker-than-expected U.S. inflation report on July 11, according to BofA Global Research.

Although Nvidia's earnings forecast came in well below lofty expectations set by the options market, stocks have proved resilient. The equal-weighted S&P 500 index, a proxy for the average stock, notched a record this week and is up about 10.5% year-to-date, helping it close the gap with the broader S&P 500.

"When market breadth improves, it suggests that a growing number of stocks are rallying on the belief that economic conditions will support earnings growth and profitability," analysts at Ned Davis Research said.

Among value stocks, General Electric is 70 per cent higher, while Targa Resources surged 68%. The Russell 2000, which is a small-cap benchmark index, is 8.5% off its lows in August but not through its peak set in July.

Looking ahead, the jobs report slated for release will likely receive considerable attention since its influence could be significant in the market given the Fed's two rate decisions in September and November.

While investors do look at other sectors now than at the start of the pandemic, technology stocks remain a driver of growth in this market, especially with ongoing attention to AI. According to data from LSEG, tech stocks are expected to report above-market earnings growth through 2025, with third-quarter earnings set to rise 15.3% compared to a 7.5% gain for the S&P 500 as a whole.

"Investors may be taking a breather after such a strong run and looking at other opportunities, but technology is still the clearest growth driver, particularly the AI theme, which is still a pretty attractive story," said Jason Alonzo, portfolio manager at Harbor Capital.