The Fed's interest rate cut is getting closer! Will the US stock market enter a "real bull market"?

Since entering a bull market in October 2022, the main reason for the rise in the US stock market has been the outstanding performance of artificial intelligence and a few large-cap stocks, which has raised concerns among investors about the lack of broad-based gains that may affect the market's continued rebound. However, this situation may be changing.

Last Thursday, better-than-expected inflation data caused the stock market to "fall into chaos." As investors quickly digested the possibility of a rate cut by the Federal Reserve in September, the most popular market sectors over the past year performed poorly, prompting investors to shift towards industries outside of technology.

ETFs tracking the seven major tech stocks leading the 2023 stock market rebound have fallen by over 1.5% in the past five days. Meanwhile, real estate and finance, two interest-sensitive industries, have emerged as the market's biggest winners during the same period. The Russell 2000 index of small-cap stocks has risen by over 7%, breaking through its 2022 high for the first time in the current bull market.

Another sign that broad-based stocks are rebounding is that the performance of the equal-weighted S&P 500 index, unaffected by stock market capitalization, is outperforming the traditional S&P 500 index.

Callie Cox, Chief Market Strategist at Ritholtz Wealth Management, stated that the recent market trends are "refreshing," which may be a sign of a mature bull market where many stocks are collectively driving the rebound, providing more support for stock indices to reach new record highs. Cox said:

"If this trend continues, if the prospect of a rate cut remains, then we may eventually see the awakening of the bull market, which is good news for all investors."

This is not the first time that strategists have been optimistic about the ongoing market rotation. In December last year and the first quarter of this year, they also cheered for the upcoming broad-based rebound. The question now is whether the gains in the US stock market are truly expanding or if the market is overly optimistic about the Fed's rate cuts.

Ohsung Kwon, Senior Equity Strategist at Bank of America Securities, said, "Our current level of confidence is higher than in December last year when the market rebound was driven by the Fed."

Kwon pointed out that the narrative driving the rebound, expectations of a soft landing and gradual Fed rate cuts, is essentially the same as before. However, this time, he stated, "The earnings backdrop does indeed support this rotation."

Bank of America's earnings analysis shows that in the current reporting period, 493 stocks excluding the "seven tech giants" are expected to achieve year-over-year profit growth for the first time since 2022. According to a mid-year outlook chart from J.P. Morgan Asset Management in June, the earnings growth of these stocks is expected to accelerate over the next few quarters, while the earnings growth of large-cap tech stocks is expected to slow down.

Given that earnings are typically a key driver of stock prices, this will support the theory of a broad-based rebound. However, the key issue is that these are just expectations. Considering the "struggles" of small and medium-sized enterprises so far this year, some strategists are hoping to see actual earnings growth to confirm the current narrative "I hope to see profit growth coming from more than just the technology sector," Cox said. "I think that's the theme of this quarter. Look at how many industries can collectively drive up the earnings expectations of the S&P 500."

The same narrative applies to the recent rotation. According to the CME Group's FedWatch Tool, the market currently expects a probability of over 90% for a Fed rate cut in September. However, Cox remains cautious about whether the broad rebound will continue.

"It's hard to say if this trade will continue before we officially enter the rate-cut cycle," Cox said. "I hope so, I'm optimistic about it, but the market will still closely watch every piece of economic data."

Kevin Gordon, Senior Investment Strategist at Jiaxin Wealth Management, is also cautious about the announcement of a significant rally, pointing out that "more clarity" on the Fed rate cut cycle and the reasons for starting the rate cut are crucial, especially for market sectors most sensitive to such changes, like small-cap stocks.

Gordon believes that the recent market action is "a significant step in the right direction." However, he stated that the broad rebound will not happen overnight. He added, "Everyone is talking about this great rotation, but great rotations often take longer than just a few days."

Even if this rotation occurs slowly, recent index performance indicates that "the path to the rise of the S&P 500 will become slower." Last Thursday, despite the encouraging June inflation report, the S&P 500 closed lower as investors sold off large-cap tech stocks that have a greater weight in the index. Cox said:

"We may see some stocks passing the baton to each other, with tech stocks handing it over to other stocks. Of course, we may not see prices rise as quickly as before, but this shift strengthens the foundation of the U.S. stock bull market, meaning this rebound may be stronger and more sustainable."