Wall Street Rotation Begins: Why Small Caps Are Beating Big Tech

Cooling job market has Wall Street betting that the Fed is done hiking rates.

Inflation also coming down fast thanks to the U.S.Iran peace deal and a big drop in oil prices, and corporate earnings are holding strong, but investors are cashing out of AI and rotating into other sectors.

Small caps are the big story.

The Russell 2000 is up about 22% in the first half of this year.

It's the best since 1991.

Now, here to break this all down is Eddie Gobor, co-founder and CEO of Key Advisors Wealth Management.

Eddie, welcome to Market Movers.

Thank you for having me.

So Eddie, as we return from the holiday weekend, all eyes are on the second half of the year.

We're looking at a cooling job market, cheaper oil, and that gives the Fed a lot to consider when we count down to the next Fed meeting.

So out of all this, what stands out to you about the economic outlook?

Well, I think one of the biggest stories right now, and it really started happening a month ago, is the rotation out of tech into some other areas that are economically sensitive as well as what's happened to the long end of the bond yields which they've started to come down and I think what that really signals because the markets are forward looking is we've probably seen peak inflation and the rate of change of inflation should start decelerating in the summer months and that's very bull.

On the margins, so this broadening out from a market perspective, we look at it as a bullish catalyst, even though it may be a headwind for the highly owned tech area in the near term from a longer term perspective over the next 12 months.

I think that signals that the economy is on solid footing and the Fed may not need to tighten as much as we had originally thought just 60 days ago.

So these are all very positive catalysts.

I think you have to proceed with caution because I don't think it's going to be a smooth ride when it comes to the Fed.

We're still not so sure they're not going to do something, whether it's tighten the balance sheet.

We don't think they'll raise rates, but they could tighten the balance sheet this summer to try to bring that in because inflation will still be sticky.

But from a broader perspective, the Fed is going to be more dovish than what the market had priced in just 60 days ago, so that's very bullish on the margins.

All right, So, this is interesting.

We saw that the Russell 2000 had its best first half of the year since 1991.

So are all small caps a true long-term value play right now?

So I think when you look at it from a sector perspective, we play it with the ETS versus individual names due to the volatility in small caps.

And when you look at small caps, they have really underperformed the broad market for quite a while and so they're just now getting started.

Last year they finally got to the 2021 highs, so it's been a long time coming for small caps and I.

I think that that trend will continue over the next 12 to 24 months.

One of the main reasons why small caps have been very under-owned by institutions, and I think you'll see more money rotate into those areas as a catch up trade.

So again, just another sign of a broadening out that there's more to the market than just tech, and again that's a good thing.

All right, Eddie, let's talk about the high risk rally.

It broadens out into the wider economy.

So is it finally time for conservative investors to pull that cash from the sidelines or stay in the money markets?

Is that the smartest play right now?

It's going to really depend on their risk tolerance.

Obviously everyone's risk tolerance is different.

Their goals and objectives are different, you know.

So from a market perspective, I think what investors have to be comfortable with before they go into the market is volatility is here to stay.

These big moves and gyrations we've seen in the market, in our opinion, is not going to go away, but we think the trend is going to be up.

So if they have the risk tolerance and time horizon, you know, our opinion is markets will certainly outperform money markets when we look at it over the next 6 to 12 months from a market perspective because again, uh, AI is going to cause a productivity boom where margins and profits we think are going to exceed to the upside, and at the end of the day, that's going to be positive for risk assets in our opinion.

All right, so Eddie, for the everyday investor watching this massive shuffle, what is your playbook right now?

So we started broadening out one of the biggest changes we made to our portfolios at the end of May was reducing our exposure to the mag 7 and going more on an equal weight perspective.

So far that's worked out really well.

Uh, some of the biggest areas we added significant percentage to versus where we were was healthcare.

We look at healthcare as a sector that can still do well in a.

Choppy summer market, which is what we've been calling for, uh, but if we're wrong and it's not choppy and it just rips to new highs, continues ripping to new highs, we think healthcare wins in both of those scenarios.

Uh, so we still have our small cap exposure.

We brought down our spy exposure and semi-exposure as well as Max 7 exposure and gone into the equal weight S&P healthcare, and then other areas investors can consider is.

Financials and industrials, and when you look at those charts over the last 30 days and look at them compared to mags and other areas, there has been a pretty wide divergence in performance, and this is, we think, just getting started.

So we think this rotation trade into those areas will outperform tech on a relative basis in the near term and then later in this year will be when you want to, in our opinion, gross back up in technology after it's gone through its correction.

All right, so Eddie, let's elaborate a little bit more on the software sector picks you might have right now.

Yes, so when we look at technology and you look at these different areas, you've had like these, we'll call them rolling crashes where areas have lost 20 to 30% of their value, and that happened to software starting last summer.

And so now when we look at performance moving forward over the next 6 months, we would prefer software over semis in the near term just due to.

The divergence we're going to see with that unwinding trade.

So you know, you look at IGV, which is an ETF we own for clients.

Other names you can look at are names like Palantir.

You can look at Microsoft.

These names have really taken a big hit.

Again.

The volatility is still going to be there, so you want to incrementally add to those areas.

And so we're playing it using the ETF, but there's going to be, in our opinion, a wider range of individual names that once we get through this summer volatility that you can really pick up and we believe get pretty well outperform broader markets when you look into the 4th quarter in the 1st half of next year.

So that's an area we would start looking at now.

So Eddie, are there any catalysts or risk factors that you're watching for specifically for the month of July and then looking into August?

In our opinion, the biggest risk to this market is the Fed.

We've been so accustomed to a very loosening cycle that has caused risk appetite to increase, and to us, if the Fed does tighten, you're going to see a pretty big unwind in our opinion, in the short term.

You will see a correction, and it's going to happen fast.

That's just the way the market structure is because of how over-owned certain areas are.

So when you look at the Fed and then you look at these IPOs that are coming out and some of the time periods when investors are allowed to liquidate out of their IPOs, that could cause an accelerated selling in the summer, whether it's July or August or September time period, which is why we think investors need to be nimble here.

Those are the biggest threats to the market.

The good news is we think those are just short term catalysts because you're going to want to buy those dips because again when we look at the fundamental outlook on the earnings and the economic growth and policy moving forward, we think the Fed may tighten once and then stay dovish the rest of the cycle.

Awesome.

Well, thank you, Eddie, for your insight.

Definitely interesting to see what's going to be happening this summer.

Thanks a lot.

Thank you.