For most of the past year, Wall Street has repeatedly warned investors that continuing to "hide in" large-cap technology stocks could be a dangerous strategy. However, this advice proved ineffective, at least for the first eleven months of last year. Through November of last year, the "Magnificent Seven," including tech giants like NVIDIA (NVDA.US), Microsoft (MSFT.US), and Amazon (AMZN.US), accounted for almost all of the S&P 500's double-digit gains. But since then, the market narrative has been shifting noticeably. The long-anticipated "rotation out of tech stocks" has now entered its fourth month, and few believe this trend will end soon.
Data shows that since early November, the equal-weighted S&P 500 index, which removes the influence of market capitalization weighting, has risen by approximately 6%, while the traditional market-cap-weighted version has gained only 1.6%. Concurrently, sectors like Materials, Healthcare, and Consumer Discretionary have replaced technology as the primary drivers of the market's advance. Small-cap stocks have been particularly standout performers, with the Russell 2000 index surging over 7% in the same period. The Invesco S&P 500 Equal Weight ETF (RSP) has attracted roughly $4.8 billion in inflows year-to-date through last Friday, ranking third among approximately 1,500 U.S. equity ETFs.
Behind this market rotation is a growing optimistic expectation among investors for the U.S. economy to "accelerate and take off." Companies more highly correlated with the economic cycle are increasingly attracting capital inflows. Simultaneously, the investment logic around artificial intelligence is no longer overwhelmingly concentrated in the tech sector; investors are beginning to differentiate between winners and losers within technology stocks themselves. Andrew Greenebaum, Senior Vice President of Equity Research Product Management at Jefferies, pointed out that market growth is expected to broaden significantly in the coming years, potentially driven by changes in fiscal policy, adjustments in monetary policy, an industrial cycle recovery, or a combination of these factors.
However, this optimism is not without risks. The labor market remains relatively cool, geopolitical tensions are intensifying, domestic instability in the U.S. is rising, and there is even a risk of another government shutdown. Furthermore, predictions of the "demise" of tech stocks have repeatedly proven to be misjudgments over the years. Despite this, signs of improving market breadth are emerging. The significant earnings advantage of tech giants, which has long far exceeded the broader market, is expected to gradually narrow, and investors are also beginning to worry about the sustainability of massive capital expenditures in the technology sector.
Lisa Shalett, Chief Investment Officer at Morgan Stanley Wealth Management, stated in a client report on January 26th that since late October last year, the leadership of the technology sector and the "Magnificent Seven" has clearly stalled. Investors are now embracing a new logic of "earnings growth diffusion" and should prepare for "new index leadership." Greenebaum emphasized to clients the "authenticity" of the rotation, highlighting three main aspects: the Russell 2000's continued outperformance versus large-caps, cyclical sectors in the S&P 500 taking over the leadership baton from tech, and a significant improvement in small-cap fund inflows in recent months.
Based on projections, the estimated full-year 2025 earnings per share growth rate for Russell 2000 constituents is 13.5%, slightly higher than the S&P 500's 12.8%, indicating that the earnings growth potential of small-caps is being repriced. Meanwhile, many investors remain skeptical, which some institutions view as an opportunity in itself. Adam Parker, Founder of Trivariate Research and former Chief U.S. Equity Strategist at Morgan Stanley, noted that his team's AI analysis of Wall Street forecasts reveals that market consensus still leans towards overweighting Technology and Financials through 2026, yet these two sectors have recently been among the worst performers.
More notably, almost no institutions are recommending heavy allocations to Energy or Materials sectors, and clients rarely inquire about resource stocks proactively, which Parker sees as a classic "contrarian signal." Data from Deutsche Bank strategist Parag Thatte also shows a significant surge in cyclical sector inflows last week: the Materials sector attracted a record $6.5 billion, Industrials saw $3 billion, Financials $2.9 billion, and Energy $1.7 billion. In contrast, tech funds experienced a net outflow of $1.4 billion, the sixth outflow in the past eight weeks.
Thatte pointed out that a similar surge in cyclical sector inflows occurred briefly after the 2024 election but quickly faded. The current rally began in mid-November, coinciding with signs of earnings growth diffusion. He emphasized, "Sustained market broadening is key for the rotation to persist, and this is precisely our base-case forecast."
Comments