The CPI inflation report Thursday morning was a nail in the coffin for the Mega cap only rally. This lower than expected inflation reading increases the odds of a Fed rate cut in September...and some thinking it may start as soon as end of July.
This flipped the switch on the S&P 500 (SPY) leading to losses on the session while the rest of the market exploded higher. This Risk On rotations is most evident in the +3.7% gain for the small caps in the Russell 2000 on Thursday.
Let’s spend our time today reviewing what likely comes next...and what that means for our investing strategy.
Market Commentary
First let me share with you the key section from my article earlier this week: Is It Time to Buy Small Cap Stocks?
First the answer to that question is YES!...and now here is the key excerpt to help set up our conversation today:
“But now I have to agree that the stars align for rate cuts BECAUSE of the clear change in language from the Fed. That paves the way for action with the 9/18 meeting being the most logical starting point.
The more curious notion is about how stocks will react given the gains already in hand for the S&P 500 (SPY) now knocking on the door of another record high at 5,600. This might usher in a classic “buy the rumor, sell the news” reaction.
Meaning that investors are always looking ahead...like 4-6 months out. That is why the stock market bottoms during bear markets well before the economy rebounds. It is the anticipation of these events that spark buying activity.
The same thing is likely taking place now. That the gains in hand are in great part about the forthcoming economic catalyst of lowering rates. So, it is possible the market stalls out, or even retreats, shortly after that first rate cut announcement.
Yet what I think is a more compelling narrative is that the S&P 500 will see a sell off. That’s because right now that is the only index clearly on the rise because of the Flight to Quality trade pushing investors to cluster in the Magnificent 7 stocks.
This has those shares priced for perfection with an appropriate round of profit taking on the horizon. That shift out of larger stocks should have more money filtering to deserving small and mid caps.
Do remember that the Russell 2000 (small cap index) is actually floating around breakeven on the year. That dramatic underperformance relative to its large cap peers will likely reverse as rates get cut leading to a more Risk On market. That typically has investors seeking more growth, which is a hallmark of smaller stocks.
Putting it altogether, we are still very much in a bull market. However, the shape of gains after rates get cut will look quite different than what has outperformed year to date.
Thus, get ready to shift to a more Risk On investing strategy as the odds of a rate cut becomes a greater certainty. And yes, a higher allocation to small caps will be on the menu as well.“
(End of previous commentary)
Indeed, what is described above is exactly what we see taking place now as the lower than expected CPI report on Thursday is pushing rate cuts to a near certainty in the eyes of investors. July 31st meeting is now up to nearly 10% odds of a cut after being close to 0% for the greater part of the last few months.
More interesting is that the September 18th meeting has moved from 50% chance of a cut to 93% chance. This is what is emboldening investors to finally make the Risk On shift in their investing which is rewarding smaller, growthier and more economically sensitive stocks to take the lead. Whereas the Magnificent 7 and their peers saw a hefty round of profit taking.
This is PRIME TIME for the POWR Ratings to shine as it has a small cap bias. This explains the across the board outperformance of our strategies Thursday...something I continue to expect in the weeks and months ahead. Enjoy the ride!
What To Do Next?
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Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com and Editor, Reitmeister Total Return
SPY shares were trading at $563.17 per share on Friday afternoon, up $6.69 (+1.20%). Year-to-date, SPY has gained 19.24%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks.
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