Tech giants fall, small caps feast! When will the big rotation in the US end? This indicator is key

Goldman says rotation from large-cap tech stocks to small caps will continue until big companies raise their revenue outlooks, according to David Kostin, strategist at the firm’s equities division.

“The Russell 2000 is outperforming the S&P 500 by at least its best five-day performance in 40 years,” he said, adding that Nvidia (NVDA.US) alone accounted for more than a quarter of the S&P 500’s 16% total return year to date.

“The six stocks — Nvidia, Microsoft (MSFT.US), Apple (AAPL.US), Alphabet (GOOGL.US, GOOG.US), Amazon (AMZN.US) and Meta (META.US) — have contributed 55% of the 16% total return year to date, but Nvidia’s stock has fallen 13% over the past seven days (despite a 138% gain year to date), while the other stocks have fallen about 7% on average (with an average return of 23% year to date),” he said.

“We believe the rotation has four reasons,” Kostin said.

1. As the Fed is poised to cut rates and inflation data has slowed, it means small caps will see lower interest expense;

2. Economic data has stabilized;

3. Market expects Donald Trump to win the US election and small caps have outperformed other companies during Trump’s presidency and are less likely to be affected by tariffs;

4. Valuation of growth stocks has tightened;

“The recent outperformance of small caps is likely to continue unless there is a significant change in the macro environment or large-cap techs report Q2 results that cause analysts to raise their revenue outlooks for the next few quarters,” Kostin said.

“In the late 1990s internet boom, revenue revisions were a key variable to watch because they ultimately signaled when the trend would turn around,” he added. “The potential recovery of AI trades — and thus the reversal of the recent underperformance of small caps relative to large caps — will depend on revenue revisions.”

“If large-cap techs beat expectations and raise their forward revenue outlooks, the S&P 500’s strong performance will resume,” he said.