Rate Cuts & Market Highs: Is a Rotation Coming?

The Fed’s widely expected rate cut last week had the chance to be a “sell the news” event, but it ended up being the opposite. U.S. stocks continued to push to new highs with tech and growth stocks still leading the way. While Powell indicated that further cuts are likely ahead soon, there’s still not much clarity around whether the upcoming cycle will be more aggressive or more measured. Either way, the market is reacting as if we’re in a late cycle bull market where growth outperforms cyclicals and defensives.

The one area that continues to look good is small caps. Lower rates will clearly help this group out, but the outperformance over the S&P 500 has been happening for more than a month. Small caps continued to do well this week even though the future path of rate cuts is still uncertain, but that may be enough for smaller companies to get a little momentum. It’s a little counterintuitive that small caps would lead at the same time that value and cyclicals are lagging, but this could be a sign that investors are ready for a rotation away from previous market leaders. These kinds of rallies have been short-lived in the recent past, so it’s premature to say that this could have legs, but the macro story kind of backs it up.