Analysis-Extended gains in the US stock market underline optimism about the economy

By Lewis Krauskopf

NEW YORK (Reuters) – Several stocks are taking part in the S&P 500’s latest march to record highs, easing concerns about a rally that has been concentrated in a handful of giant tech names for much of 2024.

The S&P 500 is on track to gain 5% in the third quarter, which ends Monday. This time, however, optimism that the Federal Reserve’s interest rate cuts will boost U.S. growth is pushing investors toward shares of regional banks, industrial companies and other beneficiaries of a strong economy and lower rates, in addition to technology-focused stocks , which have already been observed. massive gains this year.

More than 60% of S&P 500 components have outperformed the index so far this quarter, compared with about 25% in the first half of the year.

At the same time, the equal-weight version of the S&P 500 — a proxy for the index’s average stocks — gained 9% in the quarter, outperforming the S&P 500, which is more influenced by heavily weighted megacap stocks such as such as Nvidia and Apple.

The pick-up in growth is an encouraging sign for stocks, investors said, amid concerns that the market could be vulnerable to a reversal if the group of tech names backing it fell out of favor.

The “slow landing” narrative of resilient growth will be tested by employment data at the end of the week and the start of the corporate earnings season in October.

The second half of the year so far is “almost a mirror image of the first half,” said Kevin Gordon, senior investment strategist at Charles Schwab. “Even if the megacaps don’t contribute as much, as long as the rest of the market is doing well … I think it’s a healthy development.”

The Fed began its first rate cut cycle in four years earlier this month with a 50 basis point cut, a move that Chairman Jerome Powell said was intended to protect a resilient economy. Traders see an equal chance of another sizeable rate cut when the central bank meets again in November and project more than 190 basis points of cuts by the end of 2025, according to LSEG data.

Different corners of the stock market are benefiting from expectations of lower rates and steady growth.

The S&P 500’s industrials and financials sectors — seen by investors as among the most economically sensitive — rose 10.6 percent and about 10 percent, respectively, in the third quarter.

Lower rates are also a boon for stocks in smaller companies, which disproportionately struggle with high borrowing costs. The small-cap Russell 2000 is up nearly 9% this quarter.

The story continues

The market’s bond proxies — stocks with strong dividends — also attract investors looking for dividend income as bond yields fall alongside interest rates. Two such sectors, utilities and consumer staples, have climbed 18% and 8% respectively so far this quarter.

Mark Hackett, head of investment research at Nationwide, said the expansion builds on a trend that has emerged ahead of the Fed’s Sept. 17-18 meeting.

“We’re going to have this higher participation, this leveling off of performance across sectors, and then you’ve got the Fed tapering more aggressively, and that leads to … an acceleration of that trend,” he said.

“HEALTHY ENOUGH”

In all, seven of the S&P 500’s 11 sectors beat the index in the third quarter. By comparison, only the technology and communications sector, which includes Google parent Alphabet and Facebook owner Meta Platforms, outperformed the broader index in the first half of the year.

The S&P 500 is up more than 20% year-to-date to record highs.

Meanwhile, the overall influence of megacaps moderated. The combined S&P 500 weighting of the “Magnificent Seven” — Apple, Microsoft, Nvidia, Amazon, Alphabet, Meta and Tesla — fell to 31 percent from 34 percent in mid-July, according to LSEG Datastream.

“I think it’s pretty healthy that technology has taken off,” said King Lip, chief strategist at BakerAvenue Wealth Management. “We are not in a tech bear market by any means. But you definitely saw some evidence of rotation.”

Investors would likely need to see further evidence of economic strength for the expansion trend to continue. October 4 jobs data will be a test of the soft landing scenario after the previous two employment reports were weaker than expected.

Market participants will also want to see non-tech firms post strong earnings in the coming months to justify their gains.

The Magnificent Seven companies will grow earnings by about 20 percent in the third quarter, compared with a 2.5 percent profit increase for the rest of the S&P 500, according to Tajinder Dhillon, senior research analyst at LSEG. That gap is expected to narrow in 2025, with the rest of the index expected to grow earnings by 14% for the full year, compared to 19% growth for the megacap group.

In a soft landing scenario, the Magnificent Seven “shouldn’t have to shoulder the profit recovery themselves,” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, said in a recent report.

“We’re in the ‘show me’ phase for the soft landing,” Shalett said.

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Bill Berkrot)