Shares of most big tech names and AI beneficiaries, including Broadcom (AVGO -2.99%), Meta Platforms (META 0.05%), and Intel (INTC -4.28%) were down on Thursday, falling 3.1%, 3.8%, and 4.2%, respectively, as of 1 p.m. ET.
The across-the-board declines in some AI winners could happen for any number of reasons, such as bad news on the AI investment front, or a marketwide pullback.
But that's not what's happening today. In fact, Broadcom even received a big analyst upgrade.
The reason for the declines appears to be, counter-intuitively, that there was very good economic news that came out this morning. Yet with the tech sector having outpaced all others this year, investors rotated hard out of this winning sector and bought into other much cheaper stocks, especially beaten-down small-caps.
A soft inflation print causes a rotation into beaten-down value stocks
This morning, the June Consumer Price Index data was released, and it was very good news, with inflation coming in softer than expected. The headline year-over-year CPI number was 3%, down from 3.3% in May and lower than the expected 3.1% figure. On a core basis stripping out volatile energy and food prices, core CPI was 3.3%, down from the prior month and also below expectations, with the lowest reading since April 2021.
But even these numbers may be higher than what Americans are actually seeing in their daily lives, as the heavily weighted shelter component of the CPI is higher than the average. Yet the way that the shelter component is calculated operates with a lag. So last month's 5.2% increase in the index is reflecting prior increases a year ago or more, not the roughly 0.4% growth in the New Tenant Index for the first quarter, which measures rent growth in real time.
All in all, this was great news. So why would this data cause tech stocks to fall? Especially when many growth tech stocks tend to benefit from lower inflation and interest rates?
The reason is largely about the big run-up in AI tech stocks already this year. Over the first half, AI large-cap tech stocks were just about the only stocks that rallied, while many others, especially small-cap stocks, languished. This was due to the "sticky" inflation seen in the beginning of 2024, when the inflation rate decreases of 2023 appeared to plateau. As you can see, the Nasdaq-100 large-cap index and the Russell 2000 small-cap index had very different first halves:
Data by YCharts.
Small-cap stocks that make up the Russell 2000 tend to be regarded as more economically sensitive. This may be due to their higher risk, having to borrow at higher interest rates, or the fact that the small-cap index has a higher concentration of financial, energy, and industrial stocks, and less tech stock concentration than the S&P or Nasdaq large-cap indexes.
Thus, today's inflation report seems to have reassured investors that inflation is heading back to 2%. Meanwhile, job growth has remained solid, with 206,000 jobs added in June.
More evidence for a "soft landing" means a "risk-on" trade, especially to names that trade at low multiples. So with AI tech stocks having run up all year in spite of sticky inflation numbers, it appears large investors are selling those winners and "rotating" into small-caps today. At 1 p.m. ET today, the Nasdaq was down roughly 1.9%, even as the Russell 2000 was up roughly 3.1%.
The move was even enough to take down Broadcom, despite the fact that Rosenblatt analyst Hans Mosesmann raised his target on the stock from $1,650 to a whopping $2,400 today, based on continued high AI-related growth. Of note, Broadcom's stock will split after market close tomorrow.
There could be more to go in this rotation
While today is just one day, there could very well be more room to run for this rotation. According to a recent study by JPMorgan Chase analysts, the valuation differences between high-quality large-cap stocks and high-quality small-cap stocks has almost reached record levels last seen in 1999, at the end of that tech bubble. After the dot-com bubble burst, small-caps went on to outperform for the next decade.
So even after today's move, now may be a good time to look at some of your favorite small-cap stocks. But for tech investors, you can also take solace in the fact that this downdraft today doesn't really have anything to do with bad news around these companies' respective businesses.
