US stocks enter rotation mode: Tech stocks no longer "alone in beauty", cyclical stocks rise collectively, is it then the turn of small and medium caps?

The rise of US stocks is no longer dominated by technology stocks. With the market breadth index significantly improving, after the collective rise of cyclical stocks, will it be the turn of mid-cap and small-cap stocks next?

On March 31st, Ryan Detrick, Chief Market Strategist at Carson Group, revealed in a media interview that the number of S&P 500 stocks hitting 52-week highs recently reached 118, the highest in three years, indicating a continuous improvement in market breadth.

According to Dow Jones market data, more component stocks in the S&P 500 index have entered a long-term uptrend. As of the last trading day in March, over 83% of stocks closed above the 200-day moving average, the highest since August 2021.

The S&P 500 index has hit historical highs 22 times so far this year, with a first-quarter increase of 10.79%. The AI ​​boom has been a key driving force behind the stock market rally, but its influence has weakened compared to 2023.

Howard Silverblatt, Senior Index Analyst at S&P Global Indices, pointed out that data shows that the "Big Seven" tech giants in the US stock market contributed 37% of the first-quarter gain in the S&P 500 index. In 2023, the "Big Seven" tech giants drove about two-thirds of the S&P 500 index's gain.

FxPro Senior Market Analyst Alex Kuptsikevich stated in a report that in March this year, the rise of the "Big Seven" tech giants was affected by the decline of Apple and Tesla, and the performance of Amazon and Meta lagged behind the S&P 500 index.

As a whole, the "Big Seven" tech giants saw a slowing rise in March, with a market-cap-weighted increase of only 1.6%, their worst performance since December last year, while the S&P 500 rose by 2.2%.

Analysts believe that cyclical industries such as industrial, financial, and energy sectors performed well in March and the first quarter, offsetting the slowdown in large-cap tech stocks. This indicates that market leadership is spreading and is no longer overly reliant on a specific industry.

Cyclical industries are driving the rise of US stocks

Detrick stated in a media interview that sector rotation is key to a bull market. "Now, we are seeing some funds rotating from tech stocks to some cyclical stocks."

In the past month, energy, financials, materials, and industrials have performed well, with energy rising over 12% in the first quarter, financials up nearly 12%, and industrials rising over 10%. If interest rate cuts materialize, cyclical sectors are expected to expand profit opportunities along with the rate cutseToro's US stock strategist Bret Kenwell stated that cyclical industries have recently risen to record levels, which is a good sign for the continued strength of the US stock market. Kenwell said:

"Seeing industrial and financial stocks hit new highs is definitely not a sign of a bear market."

As an economic barometer and indicator, the financial sector, which is heavily influenced by monetary policy, has performed well in the first quarter. Peter Tuz, President of Chase Investment Counsel, mentioned that he recently bought shares in Goldman Sachs and oilfield service companies, while reducing his positions in tech giants, including Apple. He stated, "Market breadth is expanding, and there are more effective ways to make money this year than buying or holding onto the seven tech giants."

Bank of America stated that the Federal Reserve's information on rate cuts and quantitative tightening (QT) is favorable for bank stocks to perform well in the first quarter earnings results announced in mid-April. "The Fed's dot plot retains three rate cuts and repeatedly mentions 'soon' when discussing the timing of QT reduction. The increased confidence in easing monetary policy may lead to a lower probability of tail risks in the market, while increasing the possibility of bank stocks repeating the 'soft landing' of 1995."

Is the Next Step Small and Mid-Cap Stocks?

As the Federal Reserve approaches rate cuts, fund managers expect that small and mid-cap stocks may once again become favored and could soon lead the market.

Data shows that the S&P MidCap 400 Index itself is nearing a new high. According to FactSet data, the index closed at 3046.36 points in March, reaching a historical high. Year-to-date, the index has risen by 9.5%, almost in line with the S&P 500 Index.

However, small-cap stocks have continued to lag behind. According to FactSet data, the Russell 2000 Index is still 12% below its closing record set in November 2021. The index closed at 2124 points in March, rising by 3.2% during the month, with a year-to-date increase of 4.8%.

Barbara Reinhard, Chief Investment Officer of Voya Investment Management's Multi-Asset Strategies and Solutions platform, stated that small-cap stocks need a decisive rate cut from the Federal Reserve.

Analysis by Morningstar Wealth on data since the 1970s shows that in periods of accelerated economic growth and slowing inflation, US small-cap stocks outperform large-cap stocks. The Russell 2000 Index has an annualized return of 25.2%, compared to the S&P 500 Index's annualized return of 17.3%