Wall Street's laggards get a boost from investors rethinking their recession strategies

With fears of an imminent downturn fading, some traders have started dipping their toes into economically sensitive market areas that have been out of favour in 2023

A trader at the New York Stock Exchange. Small-cap stocks, which tend to be among the most direct beneficiaries of economic growth are among gainers. AFP

A US stocks rally is showing signs of expanding beyond the cluster of giant growth and tech names that have led gains this year, as investors reposition portfolios primed for a widely expected recession.

For months, investors piled into a handful of megacap companies seen as safe bets in uncertain times, spurring a rally that has lifted the S&P 500 nearly 12 per cent year-to-date, concentrated in a small group of stocks.

As the US economy holds up despite higher interest rates, fears of an imminent downturn are fading. Some investors have started dipping their toes into economically sensitive market areas that have been out of favour this year including small caps, energy shares and industrial stocks – all of which have seen hefty rallies in June.

“We're seeing indications that the economy is going to be more resilient to headwinds,” said Tim Murray, a capital market strategist in T Rowe Price's multi-asset division.

“There's reason to believe that the pessimism we saw at the start of the year is giving way to a stronger-than-expected market.”

Mr Murray has increased his allocation to small-cap stocks, which tend to be among the most direct beneficiaries of economic growth. The Russell 2000 small cap index of small cap companies has surged 6.6 per cent this month. The index is up 5.9 per cent year-to-date.

Other rebounding segments in June include the S&P 500 energy sector, which has gained 6 per cent this month and S&P 500 industrials, up 5.7 per cent. Energy is down 7.6 per cent year-to-date, while industrials have risen nearly 4 per cent.

By contrast, the tech-heavy Nasdaq 100 has gained about 2 per cent this month – though the recent underperformance follows a nearly 33 per cent year-to-date surge on excitement over developments in artificial intelligence.

A broadening equity rally would be a welcome development for many investors, who have worried about the market's narrow leadership. Just seven stocks – Apple, Microsoft, Alphabet, Amazon.com, Nvidia, Meta Platforms and Tesla – have been responsible for almost all of the S&P 500's gains this year, data from S&P Dow Jones Indices showed.

“This kind of dominance is unusual but you're starting to see it turn around,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

Ten of the 11 S&P 500 sectors are firmer for the month to date, compared to only six for the year. An additional sign that investors are looking further afield can be seen in the market's breadth: the percentage of S&P 500 stocks trading above their 200-day moving average stood at nearly 54 per cent on Friday, up from a low of 38 per cent in March.

That is still off from the high of 76 per cent reached in February, however.

Stronger-than-expected jobs growth and robust consumer spending have been among the data points that have bolstered investors' economic outlook.

Among the firms revising recession forecasts were Goldman Sachs, which in the past week cut its probability of a recession in the next 12 months to 25 per cent from 35 per cent, while Nuveen's chief investment officer Saira Malik recently wrote that a “mild” recession has likely been delayed from late 2023 to sometime in 2024.

Investors in the coming week will be watching US consumer price data on Tuesday for signs that the Fed's rate hikes are continuing to cool inflation without badly hurting growth.

The Fed concludes its two-day monetary policy meeting on Wednesday, and while most market participants expect the US central bank to leave rates unchanged, many will also be gauging policymakers' appetite for future tightening.

Some market watchers believe it is too early for economic optimism. Analysts at Capital Economics wrote on Thursday that the small-caps rally was likely premature, saying they expected softer growth in coming months. Jobless claims released on Thursday were higher than expected, a sign that the labour market could be cooling.

Others, however, are more optimistic. Max Wasserman, senior portfolio manager at Miramar Capital, has been increasing his positions in underperforming consumer stocks such as Starbucks and Target, respectively down around 1 per cent and 15 per cent year-to-date.

He expects restaurants and retailers to outperform as growth stabilises in the second half of the year. “That's when we think we will be rewarded,” he said.