After a torrid five-week run higher, Wall Street took its foot off the gas this week as investors moved to book some profits. The S&P 500 dropped 1.8% over the last five sessions, ending an impressive stretch that saw the broad index rally over 6% since late April.
At the core of this week’s pullback was a cooldown in red-hot technology stocks benefiting from the artificial intelligence frenzy. Semiconductor giant Nvidia, whose blowout earnings last week turbocharged the AI trade, shed over 9% this week as traders moved to cash in some of those monster gains.
Other mega cap tech leaders like Microsoft, Amazon, and Alphabet also gave back ground, contributing to a 2.4% weekly slide for the Nasdaq Composite. With Big Tech serving as a weight on the market’s shoulders, the venerable Dow Jones Industrial Average wasn’t spared either – the blue-chip index dropped over 2% itself.
The downshift marked an overdue pause that refreshed for the often overly-exuberant market. After storming nearly 15% off the lows over the previous seven weeks, a little air had to come out of the balloon, even with economic data continuing to hold up.
On the economic front, the core Personal Consumption Expenditures (PCE) reading rose 2.8% year-over-year in April, slightly exceeding estimates. While inflation remains stubbornly high, the lack of a major upside surprise helped soothe fears of the Fed needing to pivot towards an even more aggressive policy stance.
The underlying commodity and service costs feeding into the PCE suggest inflation could start to moderate in the second half of 2023. That aligns with current Fed forecasts projecting two more 25 basis point rate hikes before calling it quits on this tightening cycle.
Assuming the Fed can stick the landing without snuffing out economic growth, conditions could remain conducive for further equity upside. History shows the S&P 500 tends to bottom around six months before the end of a tightening cycle – and rally sharply in the following 12 months.
This week’s dip may have seemed like an ominous turn, but it really just returned the major indexes back in line with the performance of other segments of the market. The Russell 2000 small-cap index and Russell 3000 representing the entire U.S. equity market have been lagging the S&P 500’s advance.
Over the past month, the Russell 3000 is up a more modest 2.8% versus a 5.2% gain for the big-cap dominated S&P 500. Small-caps as represented by the Russell 2000 have fared even worse with a 1.4% advance over that span.
Analysts pointed out small-caps have struggled to sustain upside momentum. Despite bouncing back from October’s lows, the Russell 2000 is still down 6% year-to-date versus a 10% rise for the large-cap Russell 1000.
Higher financing costs, softer economic growth prospects, and the fading benefits of 2022’s rally could continue to weigh on smaller stocks in the second half.
If large-cap tech remains under pressure, it could help narrow the performance gap – with the Russell mega-caps ceding some of their market-leading gains. But for now, most of Wall Street appears comfortable viewing this week’s pullback as simply clearing the way for the next move higher.
After all, some long-overdue profit-taking and consolidation can ultimately be healthy, helping reset overbought conditions and set the stage for sustained upside.
