Investment Insights

Rotation

  • Jul 23, 2024
  • Craig Farley

Volatility reemerged from the shadows this week, flaring up amidst a sharp rotation away from the post pandemic winners of this cycle (AI-related technology shares) and towards smaller-cap and value companies. Notably, this marked the third best week of small cap outperformance over the bellwether large cap S&P 500 index since 2000.

Identifying a protagonist for the rotation is usually a fool’s errand, for the true reason will only be known in hindsight. Nevertheless, the remarkable outperformance of mega-cap technology shares, deeply concentrated positioning in the technology sector by global fund managers, and euphoric sentiment regarding the prospects of these companies all indicated that a pause for breath, or something more acute, was likely over the summer months.

When the news can’t get any better for companies, then by definition, it can only get worse, and markets have moved quickly to reflect a potentially softer outlook for growth companies this year.

Meanwhile, political events in America have dominated mainstream news headlines. The increasing likelihood of a Trump ‘clean sweep’ meaning Republican control of the Presidency, the House of Representatives, and the Senate, along with news that Trump will retain Federal Reserve Chairman Powell for the foreseeable future (if elected), has markets excited about the prospect of tax cuts and rate cuts which should be good news for smaller companies and more indebted cyclical and industrial sectors.

In a seemingly shrewd political move, Trump selected Senator JD Vance as his running mate, forming an alliance that could help secure votes across the crucial swing states of the US industrial Midwest. Technology titan Elon Musk called the decision ‘a great choice’ and said the combined lineup ‘resounds with victory’ on his social platform X.

The trading week closed out with an announcement from incumbent President Joe Biden that he would, following mounting internal party pressure, step aside from the US election race. Kamala Harris looks most probable at this stage as the Democratic candidate to challenge Donald Trump in the race for the White House, with the winner set to be announced in early November.

Pouring fuel on the ‘rotation fire’ was startling news of the biggest IT outage in history, as countless businesses and individuals all over the world grappled with the dreaded ‘blue screen of death’.

The IT failure affected airlines, banks, broadcasters, and healthcare providers from the US and Europe to Australia, Japan, and India. It is another example of how a minor technical change, in this case CrowdStrike’s minor security update to the Microsoft operating system, can wreak widespread havoc.

CrowdStrike, a company unknown to most outside of the IT industry, is one of the largest providers of ‘endpoint’ security software, which protects connections between computer networks and remote devices, from laptops, phones, and servers, to retail payment terminals and cash machines.

In what may be regarded as a perfect storm for the technology sector, semiconductor chip makers, the darlings of this bull market, were aggressively sold off following news that the Biden administration had told allies it was considering severe export curbs if companies such as Tokyo Electron and ASML Holding continued to provide China with access to advanced semiconductor technologies.

In other corporate news, the world’s biggest watchmaker, Swatch Group, reported a sharp fall in first half sales and earnings as weaker demand in China heavily impacted sales, whilst European luxury goods company Hugo Boss plunged after cutting its sales outlook, also flagging challenges in China.

Looking to the week ahead, investors will be watching Thursday’s scheduled release of the US government’s initial estimate of second-quarter GDP. The report is expected to show that the economy accelerated relative to the first quarter, with the whisper number of +2.7% making the rounds. Corporate earnings season is also in full swing, and results and guidance from corporate America, including Alphabet and Tesla, will likely play a big part in determining the short-term path ahead for asset prices.

(Cover Image Source: Karsten Würth)

TEAM Asset Management is a trading name of Theta Enhanced Asset Management Limited which is regulated by the Jersey Financial Services Commission.