Broadening Gains in the US Stock Market Underscore Optimism on Economy

The recent activities in the US stock market reveal a wave of optimism regarding the country’s economic outlook. As the S&P 500 approaches record highs, an increasing number of stocks are participating in this rally, alleviating earlier apprehensions about excessive reliance on a few large tech companies. The index is projected to gain approximately 5% in the third quarter, which concludes on Monday. Investors’ sentiments are buoyed by expectations that the Federal Reserve’s anticipated rate cuts will stimulate growth in the US economy.

Shift Towards Diversification

This quarter has seen a noteworthy shift where more than 60% of S&P 500 stocks have outperformed the index, a significant increase from about 25% during the first half of the year. Notably, the equal-weighted version of the S&P 500, a more indicative measure of the average stock’s performance, has surged by 9% this quarter. This contrasts sharply with the heavily weighted stocks of technology giants like Nvidia and Apple, demonstrating a broader market participation.

Healthy Market Dynamics

Market analysts view this broadening rally as a reassuring signal, particularly in light of concerns that a downturn could occur if the leading tech stocks falter. According to Kevin Gordon, senior investment strategist at Charles Schwab, the dynamics of the market in the second half of the year appear to mirror its earlier half, illustrating the health of the current market climate.

The Federal Reserve initiated its first rate-cutting cycle in four years with a significant reduction of 50 basis points earlier this month. Federal Reserve Chairman Jerome Powell emphasized that this move aims to safeguard the resilient economy. Market traders foresee a possibility of further substantial rate cuts in future meetings, with projections hinting at over 190 basis points of cuts through the end of 2025, according to LSEG data.

Beneficiaries of Lower Rates

Various sectors of the stock market are reaping the benefits of anticipated lower rates and sustained economic growth. Particularly, the industrial S&P 500’s industrial and financial sectors have shown significant performance, rising by 10.6% and around 10%, respectively, in the third quarter. This positive momentum is particularly advantageous for smaller companies, which are often more susceptible to high borrowing costs. The Russell 2000, a small-cap focused index, has gained nearly 9% this quarter. Furthermore, stocks regarded as “bond proxies” — those with strong dividend offerings — are attracting investor interest as bond yields decline. As a result, sectors like utilities and consumer staples have enjoyed impressive gains this quarter, climbing by 18% and 8%, respectively.

Reinforced Trends and Sector Performance

Mark Hackett, chief of investment research at Nationwide, noted that the current broadening trend began gaining traction even prior to the Fed’s aggressive measures. He suggests that the expectation of expanded participation across various sectors has continued to manifest following the recent Fed meeting. Currently, seven of the S&P 500’s 11 sectors are outperforming the index, a significant increase from the first half of the year when only technology and communication sectors were leading.

The Role of Gigantic Companies

Despite the increased participation of diverse sectors, the ongoing influence of large-cap stocks seems to be moderating. The collective weight of the “Magnificent Seven” — which includes companies like Apple, Microsoft, Nvidia, Amazon, Alphabet, Meta, and Tesla — has decreased from 34% in mid-July to 31% now.

King Lip, chief strategist at BakerAvenue Wealth Management, views this consolidation in the tech sector as a positive development, indicating a healthy rotation in the market rather than a downturn for tech stocks.

The Path Ahead

Continued signs of economic strength will be pivotal for sustaining this broadening trend in the stock market. The jobs data set to be released on October 4 will be a significant indicator of the “soft landing” narrative, especially following two recent employment reports that fell short of expectations. As companies gear up for the upcoming corporate earnings season, market participants are eager to see consistent performance from non-tech firms to validate their gains. Analysts project that the Magnificent Seven are likely to report a profit increase of 20% in the third quarter, in stark contrast to the expected 2.5% rise for the rest of the S&P 500. This gap is anticipated to narrow in 2025, further substantiating the importance of a diverse and robust earnings landscape.

Ultimately, as Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, aptly put it, the market is currently in a “show me” stage regarding the potential for a soft landing.