The Bottom Line:
- Potential bearish trends for the tech sector if Trump returns to power, while other sectors could thrive
- The Yen carry trade and its influence on the surge in small businesses and the selloff in NVIDIA and other large-cap tech names
- The divergence between the S&P 500’s overall performance and the rally in smaller firms, driven by investor optimism in the broader economic outlook
- The possibility of increased volatility as the US election approaches, with a potential Republican victory benefiting small-cap equities
- The historical precedent of small-cap and value stocks outperforming during bear markets, raising questions about the sustainability of the current market rotation
Potential Bearish Trends for the Tech Sector under Trump’s Return
Potential Risks for Tech Giants Under a New Administration
If Donald Trump returns to power in the 2024 elections, the tech sector might face bearish trends, according to Michael Ged, a seasoned portfolio manager at Tidal Financial Group. Ged suggests that a shift in social mood and the Republican Party’s focus on creating more opportunities for smaller businesses and promoting equality across sectors could lead to tech giants being hit hard. As tech stocks have been the primary driver of market momentum, a downturn in this sector could have significant implications for the overall market.
Small Caps and Value Stocks Poised to Benefit
While the tech sector may struggle under a Trump presidency, other sectors could thrive. Small cap equities, in particular, might benefit from anticipated tax cuts. The recent surge in the S&P SmallCap 600 Index, which hit a new 52-week high with a substantial 5-day surge of 10%, reflects this optimism. Similarly, value stocks, which tend to have a lower allocation to the tech sector, may outperform growth stocks. This shift in sector strength could be attributed to a mechanical dynamic caused by managers unwinding their spread trades, which involve shorting value sectors like financials and going long on tech.
Defensive Tone Beneath the Surface
Despite the potential for small caps and value stocks to outperform, there are concerns about the sustainability of this trend. Historically, when value outperformed growth, it occurred during bear markets, such as in 2020 and early 2022. The question remains whether this time will be different, with value and small caps leading the market higher in a bull market. However, the lack of strong earnings support for these sectors poses a challenge to this narrative. As the U.S. election approaches, increased volatility is expected, and the outcome could have a significant impact on the performance of various market segments.
The Yen Carry Trade and Its Impact on Small Businesses and Tech Stocks
Potential Risks for Tech Giants Under a New Administration
If Donald Trump returns to power in the 2024 elections, the tech sector might face bearish trends, according to Michael Ged, a seasoned portfolio manager at Tidal Financial Group. Ged suggests that a shift in social mood and the Republican Party’s focus on creating more opportunities for smaller businesses and promoting equality across sectors could lead to tech giants being hit hard. As tech stocks have been the primary driver of market momentum, a downturn in this sector could have significant implications for the overall market.
Small Caps and Value Stocks Poised to Benefit
While the tech sector may struggle under a Trump presidency, other sectors could thrive. Small cap equities, in particular, might benefit from anticipated tax cuts. The recent surge in the S&P SmallCap 600 Index, which hit a new 52-week high with a substantial 5-day surge of 10%, reflects this optimism. Similarly, value stocks, which tend to have a lower allocation to the tech sector, may outperform growth stocks. This shift in sector strength could be attributed to a mechanical dynamic caused by managers unwinding their spread trades, which involve shorting value sectors like financials and going long on tech.
Defensive Tone Beneath the Surface
Despite the potential for small caps and value stocks to outperform, there are concerns about the sustainability of this trend. Historically, when value outperformed growth, it occurred during bear markets, such as in 2020 and early 2022. The question remains whether this time will be different, with value and small caps leading the market higher in a bull market. However, the lack of strong earnings support for these sectors poses a challenge to this narrative. As the U.S. election approaches, increased volatility is expected, and the outcome could have a significant impact on the performance of various market segments.
Diverging Fortunes: S&P 500 Performance vs. Small-Firm Rally
The Yen Carry Trade and Its Impact on AI Stocks
The recent surge in the Japanese Yen has had a significant impact on the AI momentum trade. Investors have been borrowing capital from Japan at low interest rates and deploying it into hot stocks, including AI-related companies like Nvidia. However, as the Yen appreciates, it affects these carry trades, leading to a selloff in higher-risk assets. When the Yen rises, the cost of borrowing increases, and investors may sell off their AI stocks to mitigate losses or rebalance their portfolios. This relationship highlights the sensitivity of tech and AI stocks to currency fluctuations and broader financial strategies.
Small Caps Benefit from the Unwinding of Spread Trades
The appreciation of the Yen and the subsequent selloff in large-cap tech names have created an opportunity for small caps to rally. Hedge funds have been employing a spread trade strategy, shorting small caps and buying large caps to play the differential. However, with the selloff in large caps, this spread trade has gone against them, leading to a significant short-covering rally in small caps. While some argue that this is the start of small-cap relative momentum, the sustainability of this trend remains uncertain. Small caps have been highlighted as holding the key to market performance for some time, but the lack of strong earnings support poses a challenge to this narrative.
The Divergence Between the S&P 500 and Small-Firm Performance
Despite the S&P 500 setting back-to-back records in the first half of the year, the index’s performance has been significantly influenced by its largest and most impactful sectors. While economically sensitive sectors like energy, industrials, and financials have shown gains, the S&P 500’s overall performance has declined due to the underperformance of its most significant sector: tech. On the other hand, smaller firms have experienced a rally of nearly 10% in July, bringing a broader shift in market dynamics. This divergence shows growing confidence in the overall economic outlook and a belief that the market can continue to thrive beyond the influence of the tech giants.
Increased Volatility and the Potential Benefit for Small-Cap Equities
The Interconnectedness of Global Financial Markets
In today’s globalized economy, financial markets are highly interconnected, and events in one part of the world can have significant implications for investors elsewhere. The recent surge in the Japanese Yen and its impact on the AI momentum trade is a prime example of this phenomenon. As investors borrowed capital from Japan at low interest rates to invest in high-growth AI stocks, the appreciation of the Yen led to a selloff in these assets. This highlights the importance of understanding the complex web of relationships between different asset classes, sectors, and geographies when making investment decisions.
The Potential for Small Caps to Outperform in the Current Market Environment
While the tech sector has been the primary driver of market momentum in recent years, there are signs that small caps may be poised for a period of outperformance. The unwinding of spread trades, which involved shorting small caps and buying large caps, has led to a significant short-covering rally in small caps. Additionally, the anticipation of tax cuts and a shift in focus towards creating opportunities for smaller businesses could provide further tailwinds for this segment of the market. However, the sustainability of this trend remains uncertain, given the lack of strong earnings support for small caps.
The Importance of Sector Allocation in Portfolio Management
The diverging fortunes of the S&P 500 and small-firm stocks highlight the importance of sector allocation in portfolio management. While the S&P 500 has been weighed down by the underperformance of its largest sector, tech, economically sensitive sectors like energy, industrials, and financials have shown gains. This underscores the need for investors to maintain a well-diversified portfolio that is not overly reliant on any one sector or asset class. By spreading investments across a range of sectors and market segments, investors can potentially mitigate risk and capitalize on opportunities in different parts of the market.
Historical Precedent: Small-Cap and Value Stocks in Bear Markets
The Yen Carry Trade and Its Impact on Small Businesses and Tech Stocks
The recent exchange rate movement between the US dollar and the Japanese Yen has had significant implications for investors. With the Yen appreciating, it impacts the carry trade strategy, where investors borrow funds in a low-interest currency like the Yen and invest in assets that offer higher returns in dollars. This has led to a selloff in higher-risk assets, including AI stocks, as the cost of borrowing increases when the Yen rises. Nvidia, along with other tech companies, faced a decline that can be attributed to the broader momentum affecting AI stocks influenced by the carry trade dynamics.
Small Caps Poised to Benefit from Political and Economic Shifts
While the tech sector may face challenges, the current situation seems favorable for small caps. Michael Ged, a seasoned portfolio manager at Tidal Financial Group, suggests that if Donald Trump returns to power in the 2024 elections, there could be a focus on creating more opportunities for smaller businesses and promoting equality across sectors. This shift in administration could potentially benefit small-cap equities due to anticipated tax cuts. The recent surge in the S&P SmallCap 600 Index, hitting a new 52-week high with a substantial 5-day surge of 10%, reflects this optimism.
Value Stocks and the Unwinding of Spread Trades
In addition to small caps, value stocks may also benefit from the current market dynamics. Value stocks tend to have a lower allocation to the tech sector, which could help them outperform growth stocks. The shift in sector strength could be attributed to a mechanical dynamic caused by managers unwinding their spread trades, which involve shorting value sectors like financials and going long on tech. However, there are concerns about the sustainability of this trend, as historically, when value outperformed growth, it occurred during bear markets. As the U.S. election approaches, increased volatility is expected, and the outcome could have a significant impact on the performance of various market segments.
