Thursday wasn’t a great day for hedge funds long on megacap tech stocks and short on the rest of the market. A cooler-than-expected June consumer-price index (CPI) reading appeared to spark a rotation into previously unloved sectors.
“Hedge funds are blowing up today,” said Jay Hatfield, CEO of Infrastructure Capital Advisers, referring to strategies focused on long positions in large-cap tech stocks and short bets against small- and mid-cap stocks.
While this strategy had been profitable amid a rally led by a select group of tech favorites in 2024, the landscape changed abruptly. Small-cap stocks surged, with the Russell 2000 index up 3.6%, while the Nasdaq Composite slumped 2%.
This marked the biggest one-day outperformance for the Russell over the Nasdaq since records began in 1986, according to Dow Jones Market Data.
The big question for investors is whether this rotation is temporary or the start of a broader rally, following a period of historically concentrated market leadership. Market analysts noted sharp rises in baskets tracking heavily shorted stocks, suggesting the squeeze could continue for some time.
On Thursday, the S&P 500 pulled back 0.9% after reaching a record intraday high, while the Dow Jones Industrial Average gained 0.1%. The consumer-price index fell 0.1% in June, slowing the year-over-year rate to 3%.
The core rate, excluding energy and food costs, rose 0.1%, slowing to 3.3% from 3.4%. Economists caution that more data will be needed to ensure a September rate cut by the Federal Reserve, but fed-funds futures traders now see a better than 90% probability of at least a quarter-point reduction, according to the CME FedWatch Tool.
The Magnificent Seven megacap tech stocks, which had led the rally since October 2022 on AI enthusiasm, were each down at least 2% by midday Thursday. This resulted in a market cap drop of more than $500 billion, the largest single-day wipeout since September 13, 2022.
Despite the decline in heavyweight tech stocks dragging down the S&P 500, around 80% of the index’s stocks were higher on the day. The equal-weighted S&P 500 outperformed its market-cap-weighted version by around 1.8 percentage points, marking the biggest relative gain since January 2021.
Hatfield, also the portfolio manager of the InfraCap Small Cap Income ETF, sees potential for the rally to broaden as the market anticipates continued cooling inflation readings and eventual Fed rate cuts. He expects the overall market to extend its run, having recently raised his year-end target for the S&P 500 to 6,000.
A September rate cut by the Fed could continue a trend of global central banks injecting liquidity into the banking system, which historically has boosted both stocks and bonds. Although the S&P 500’s pullback Thursday was exacerbated by the tech selloff, Sonu Varghese, global macroeconomic strategist at Carson Group, believes it won’t be a lasting drag on the index.
He anticipates that large-cap value stocks could rally and support the index’s forward momentum, even if tech consolidates.
