The last few weeks have seen a significant rotation from the mega-caps to everything else. Over the past month, the Magnificent 7 are down more than 10%, while the S&P is down 1%, the S&P Equal weight is up 6%, and the Russell 2000 is up 11%. Money is rotating aggressively.

 

Why is this rotation happening? The quick answer is the market is expecting a change in the slope of the yield curve. The yield curve is a visual representation of how much it costs to borrow money for different periods of time; it shows interest rates on U.S. Treasury debt at different maturities at a given point in time. A normal yield curve slopes upwards and to the right. Below are 3 examples of normal yield curves at 3 different times in the past. As you can see, the yield on bonds usually goes up as the maturity date of the bond extends.

 

 

Below is what the current yield curve looks like. As you can see, the rates on short term government debt are higher than long term debt. This kind of yield curve is known as an inverted yield curve. It usually happens when the Federal Reserve is trying to slow down the economy. Over the last few weeks, we have seen inflation data that appears to suggest that inflation is not just coming down but has reached its 2% target. If true, this means the federal reserve is going to start cutting rates. The Bank of Canada has already cut its key lending rate twice. If the Federal Reserve begins to cut rates in September, which we believe they will, and continues to cut rates over the next six months, then the top left portion of the red line below will drop down and we will get back to a normal yield curve. This would be very beneficial for many companies that have not participated in the market over the past two years. This is why the rotation away from mega-caps is happening. The market believes that the Federal Reserve is going to begin to cut interest rates and the next cycle will begin. Stay tuned!

 

 

I have also included a piece from our CIBC economics team entitled “Monthly World Market Report”.

 

As always, if you have any questions, please feel free to give us a call at any time.

 

Have a great long weekend.

 

Milan