What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

Simply put, it’s been a whirlwind two weeks for the financial markets. After the June CPI report showed that inflation has been essentially flat for two straight months, the markets have been in the midst of a massive rotation. Out of favor are previous winners, including mega-caps, tech and growth. In favor again are long-term laggards, such as small-caps, value and dividend stocks.

As I noted earlier this week, there’s still some question as to 1) what this shift means and 2) is it sustainable. I see a few things happening here:

• Equity market gains have broadened out substantially and market breadth has improved. Take away tech and the magnificent 7 stocks, U.S. stocks have had a pretty positive reaction overall. This is supported by ETF flow data, which shows a lot of money still pouring into equities.

• Volatility, while rising modestly, is still mostly contained and Treasuries have not made a significant rally. That suggests that investors haven’t panicked yet and this may just be a normal rotation within equities, albeit a very aggressive one.

Given this, I think conditions are still favoring stocks and that means we might get another reversal back into large-caps and tech. The economy is slowing here, but we don’t yet see anything necessarily falling off of a cliff that would spook investors. I think that the more that volatility remains suppressed, the greater the chance we see of a reversal back into previous leaders.

From a flows standpoint, we have seen a big increase in money going into small-cap ETFs (on a relative basis). There’s always an aspect of performance chasing in rallies like this and I can see that trend continuing, but I wouldn’t be surprised at all if tech stages a comeback.

Key Economic Reports This Week

The calendar is going to be very light in the first half of the week, but big in the second. The first reading on Q2 GDP in the U.S. will be critical given how Q1 GDP came in much lower than expected. The current estimate of 2% could be enough to convince investors that the economy is still in good shape, but another miss would add more ammunition to the slowdown argument.

Friday’s release of both the latest inflation and spending data will give the markets a good sense of whether or not consumers are still holding up. If the rising unemployment rate is an early sign that consumer financial conditions are getting tighter, we might start seeing it here too.

Dividend Landscape

The past two weeks have been all about small-caps, but the market rotation has benefited dividend stocks nearly as much. The pivot into value, low volatility and cyclicals fall right into the wheelhouse of the dividend income strategy. If dividend stocks are to continue this trend, we might need to see some weakness in this week’s economic data. The small-cap rally was ignited by weak inflation and a growth warning from Jerome Powell. It makes sense that dividend stocks could get another bounce (or at least outperformance) if the slowing economy narrative picks up some speed. If GDP growth and spending look solid, it increases the likelihood of a return to tech.

Market Outlook

Given what’s happened over the past two weeks, it would make sense that the pendulum swings back in the other direction. If small-cap momentum returns in the first half of the week, we could be looking at real strength in this rotation. I still think there’s a good chance that this small-cap rally turns out to be a fake-out that eventually results in the return of tech.

This week, however, could be a coin flip. The full-week results might depend heavily on where the data lands at the end of the week. Since Treasuries didn’t really move last week, I don’t think we’re looking at a flight to safety scenario, which means stocks are still in favor.

Looking better for: large-caps, utilities, junk bonds

Looking worse for: momentum, emerging markets, airlines