Analysis: Broadening Gains in U.S. Stock Market Highlight Optimism About the Economy By Reuters

By Lewis Krauskopf

NEW YORK (Reuters) – An increasing number of stocks are joining the S&P 500’s recent rally towards all-time highs, alleviating concerns over a market that had largely relied on a few major technology companies for much of 2024.

The index is poised to gain 5% in the third quarter, ending on Monday. This surge in optimism, driven by expectations that the Federal Reserve’s rate cuts will bolster U.S. economic growth, has led investors to explore shares of regional banks, industrial firms, and other sectors that stand to benefit from a robust economy and lower interest rates, alongside the tech stocks that have already enjoyed substantial gains this year.

Over 60% of S&P 500 constituents have outperformed the index this quarter, a stark contrast to around 25% in the first half of the year. Additionally, the equal-weight version of the S&P 500 – which reflects the average performance of the index’s stocks – has risen 9% in the quarter, surpassing the more influential S&P 500, which is significantly impacted by the large-cap stocks like Nvidia and Apple.

This broadening rally is viewed as a positive development for the stock market, as investors had previously worried about the potential for a reversal if the big tech names supporting the market lost their appeal.

The narrative of a "soft landing," indicating stable growth, will be put to the test with upcoming employment data and the onset of the corporate earnings season in October.

According to Kevin Gordon, a senior investment strategist, the latter half of the year mirrors the first half, albeit with different dynamics. "Even if the megacaps aren’t contributing as much, if the broader market performs well… I believe that’s a healthy trend," he remarked.

Earlier this month, the Fed initiated its first rate-cutting cycle in four years with a 50-basis point reduction, a move aimed at ensuring continued economic resilience. Market traders are anticipating a significant chance of further cuts at the Fed’s upcoming meeting in November, and projections suggest over 190 basis points of cuts could occur through the end of 2025.

Various sectors of the stock market are capitalizing on expectations of lower rates and steady growth. The industrial and financial sectors within the S&P 500, regarded as economically sensitive, have risen by 10.6% and approximately 10%, respectively, in the third quarter. Meanwhile, smaller companies, which often face more challenges with high borrowing costs, have also seen gains, with small-cap indices rising nearly 9% this quarter.

Additionally, sectors that provide stable dividends are drawing investors looking for income as bond yields decrease with falling interest rates. The utilities and consumer staples sectors have risen by 18% and 8%, respectively, in the same quarter.

Mark Hackett, head of investment research at a major financial services firm, noted that this broadening trend had already begun prior to the Fed’s recent meeting, implying that the aggressive rate cuts have accelerated this positive movement.

Currently, seven of the eleven S&P 500 sectors are outperforming the index in the third quarter. In contrast, only the technology and communications sectors excelled in the first half of the year.

The S&P 500 has risen more than 20% year-to-date, achieving record highs. Meanwhile, the influence of major tech stocks has decreased slightly; their total weight in the S&P 500 has dropped from 34% in mid-July to 31%.

King Lip, a chief strategist, finds this consolidation in tech stocks to be a positive sign. "It’s not a bear market for tech, but there is clear evidence of sector rotation happening."

Investors are likely to seek further evidence of economic robustness for this trend to persist. Employment data on October 4 will be a crucial indicator following two previous disappointing reports.

Furthermore, market participants will be eager to see strong earnings reports from non-tech companies in the coming months to validate their recent stock price increases.

Major tech companies are projected to see earnings growth of around 20% for the third quarter, in contrast to an estimated 2.5% growth for the rest of the S&P 500. However, this disparity is expected to narrow in 2025, with projections indicating a 14% increase in earnings for the broader index against a 19% rise for the major tech firms.

In a scenario of stable economic growth, major tech companies shouldn’t have to carry the overall profit recovery on their own, according to a recent report from a chief investment officer at a well-known financial firm. "We’re currently in the ‘show me’ phase regarding the soft landing," she concluded.