Why this strategist says the tech rotation 'has some legs'

The tech sector (XLK) has been experiencing a market rotation with investors pivoting into small caps (^RUT). State Street Global Advisors US SPDR Business chief investment strategist Michael Arone joins Morning Brief to discuss his market outlook.

Arone identifies "a trifecta of positive news" that triggered the rotation within the tech sector: cooler-than-expected inflation reports, Federal Reserve Chair Powell hinting toward interest rate cuts, and Powell's acknowledgment that he didn't see inflation reaching 2%.

However, this earnings season has shown that "good is not good enough" for the Magnificent Seven tech stocks. Despite top and bottom line beats, any weakness in AI or cloud businesses has been "a hindrance to the stock," suggesting that the rotation "has some legs."

Amid this shift, Arone highlights financials as an attractive sector, noting increased M&A activity and improving earnings. Arone also points to the insurance industry, saying it's "an area where they have pricing power."

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Angel Smith

Video Transcript

Chips sows are rallying on the final trading day of the month.

You've got NVIDIA leading the charge.

Now today's moves come amid a tough couple of weeks for Big Tech, the NASDAQ actually on track to have its worst month of the year.

Comparing that to the this rotation that we've seen into small caps.

The Russell 2000 actually on track for its best monthly performance of 2024.

So for more on some of the rotation that we've seen and what's ahead we to bring in Michael Rooney, he's State Street Global Advisors, Chief Investment strategist Michael.

It's great to have you here.

So we're seeing some excitement surrounding the chip names.

Once again, you've got NVIDIA really this leg hire uh clearly at the open.

I'm curious what you make of that recent rotation out of tech and maybe whether or not today's buying action signals that we could see a leg hire here for some of the names that have been.

Um Well, I certainly think that there was a trifecta of positive news that led to the leadership rotation that was the cooler than expected inflation report then.

Certainly, Chairman Powell set the stage for rate cuts.

So we'll get more information today at the FO MC meeting.

But he suggested that one of the risks was staying too high for too long.

And he also let the markets know he didn't need to wait for inflation to get to 2%.

Now, you've seen interest rates fall and you've seen a rotation in leadership and what's been interesting shown us so far in this earnings season is that good?

Hasn't been good enough for high priced mag seven stocks.

So they've beaten on top line and beaten on bottom line yet.

Subtle nega negative kind of slowdowns whether it's cloud computing or youtube advertising has really kind of been a hindrance for the stock.

So I think the rotation has some blanks.

Ok. And so where is the rotation into from what we're seeing in the flows right now, Michael?

So I certainly think when I look at the earnings, one of the things that's been interesting is financial started off the quarter as not expecting all that much.

And Jared just showed right.

Financials is one of the top performing sectors this month.

So we've started to see that earnings expectations for five financials have increased dramatically and banks in particular.

So I think as the yield curve has steepened, so short term rates are falling long term rates are falling, perhaps not as much profitability is quite high.

They return capital to shareholders through dividends and buybacks.

And I think financials is one of those areas that uh remains attractive and we're seeing part of that rotation into Michael.

Where within financials are you seeing the most opportunity?

Do you, do you like how the positioning of some of the regionals or is it more some of the larger US banks where you're seeing the most opportunity, given the rotation and given what we're expected to hear from the Fed?

I think it's more of the larger of the larger banks.

Excuse me, in terms of my expectation is is that their investment banking activities, picking up m and A activities picking up, uh their earnings are picking up from that perspective and I just think that they have a broader kind of set up business.

So I think kind of large money center banks are attractive.

The JP Morgan's, the Bank of America's, their earnings were good.

They guided higher, highly profitable.

The economy continues to do reasonably well.

So loan growth should be ok, particularly as rates come down.

And what's happening with interest rates is improving their overall financial health and profitability.

We also like insurance.

That's an area where they have pricing power.

And so anyone who's got home insurance, car insurance, unfortunately, it's been going up and going up quite significantly at a time when their cost structure hasn't changed all that much.

So we like insurance and we also like uh large banks within financials, Michael.

We got a big fed decision today.

Well, not, not a huge fed decision today.

Let's be real.

I mean, we're looking at the probability.

It's essentially duddy right now.

So how much of what the fed says today really teased them up for a cut in September?

So, Brad, I think here, the risks are kind of skewed to the downside.

And the reason why I say that is the market is pricing in with 100% certainty that the fed will begin to cut rates in September.

And so here it leaves the fed very little wiggle room today.

So I think everybody's expecting that they'll signal in the FO MC statement that rates are, that are rate cuts are coming.

They're likely to say, hey, we, we've gained greater confidence that inflation is headed towards the 2% trajectory.

I think Powell doubled down on that and the post meeting presser.

But if he doesn't, I think you could see a negative reaction from markets.

So the fact that there's 100% agreement that the fed will cut rates in September suggests that there's very little wiggle room for the Fed today, so they better deliver.

Otherwise you're going to see a market reaction.

Michael Laroy, who is the State Street Global Advisors, Chief Investment strategist of the US S Spider Business.

Thanks so much for joining us here this morning.

Appreciate it.

Thanks, Rob.