BofA strategists note that a lower Treasury yield combined with an improving manufacturing PMI has historically led to the outperformance of the equal-weighted S&P 500 index.
In the past week, there has been a significant shift towards U.S. small-cap stocks, causing investors to consider if this trend marks a rotation away from this year’s Big Tech leaders.
BofA Global Research strategists suggest that for this rotation to be sustained, the 10-year Treasury yield needs to stay below 4%, and the ISM manufacturing PMI index should be above 50%.
Historically, the S&P 500 equal-weighted index has outperformed the market-cap-weighted S&P 500 90% of the time when the 10-year Treasury yield dropped by more than 1 percentage point from its 12-month peak, and the ISM manufacturing PMI improved by more than 4 percentage points from its 12-month low, according to a note from BofA strategists led by equity and quant strategist Ohsung Kwon.
For the stock-market rotation to continue, investors need to see the 10-year yield at around 3.99%, below its 52-week closing high of 4.99% on October 19, and an ISM manufacturing PMI index above 50%, indicating expansion in the manufacturing sector.
“The manufacturing economy is in the second-longest downturn in history, with 21 months without two consecutive months of PMI above 50%,” Kwon and his team wrote. They attribute this largely to the destocking cycle, which they expect to moderate in the second half of 2024.
In June, the Institute for Supply Management’s manufacturing index dropped to 48.5% from 48.7% the previous month, with the lowest level in the past 12 months being 46.5% in July 2023. A PMI below 50% signals contraction in the sector.
On Monday, the yield on the 10-year Treasury rose by 2.1 basis points to 4.259%, influenced by speculation that Vice President Kamala Harris might be the Democratic Party’s nominee for the White House. This year, the 10-year rate has increased by nearly 40 basis points due to persistent inflation concerns, keeping the Federal Reserve cautious about cutting interest rates, according to FactSet data.
Nevertheless, traders in the federal-funds futures market on Monday saw a 93.6% probability that the Fed will start cutting its benchmark rate in September, based on the CME FedWatch Tool, although policymakers will consider forthcoming inflation data before deciding on a rate cut at the end of summer.
U.S. stocks ended higher on Monday, led by the “Magnificent Seven” and chip stocks like Nvidia, which rose by 4.76% after a tough week.
The Nasdaq Composite increased by 1.6%, the S&P 500 by 1.1%, and the Dow Jones Industrial Average edged up by 0.3%, according to FactSet data.
