Megacaps need enhanced guidance to stop an “epic” momentum reversal

According to Goldman Sachs, the rotation from megacap high-tech momentum trades to small-cap stocks will continue until major companies raise earnings guidance.

Stock strategist David Costin wrote that Russell 2000 (RTY) (NYSEARCA: IWM) recorded the strongest 5-day outperformance in at least 40 years against the S&P 500 (SP500) (NYSEARCA: SPY) (IVV) (VOO).

“NVDA (NVDA) alone contributed more than a quarter of the S&P 500's 16% YTD total return.

“Together with Microsoft (MSFT), Apple (AAPL), Alphabet (GOOGL) (GOOG), Amazon (AMZN), and Meta (META), these 6 stocks contribute 9pp and 55% of 16% YTD returns. “However, NVDA's stock price has plummeted 13% over the past 7 days (it is still up 138% for YTD). Other stocks have generally declined by about 7% (even so, YTD returns average 23%).”

Costin says there are 4 reasons for this rotation:

The Fed's interest rate cut is imminent, and the inflation rate is declining.
Stable economic growth data.
During President Trump's term of office, small-cap stocks have outperformed, and since they are less likely to be affected by tariffs, expectations for Trump's victory.
Reduction in growth premiums for large stocks.

“The recent trend of small-cap outperformance will continue unless the macro environment changes drastically, or unless megacap tech stocks announce second quarter results and analysts raise earnings forecasts for the next few quarters.

“During the dot com boom in the latter half of the 1990s, sales revisions were an important variable to watch out for. “The possibility of resuming AI trading, and in turn, the possibility of a recent reversal of underperformance between large stocks and small caps depends on sales revisions.

“S&P 500 outperformance resumes when major high-tech companies revise their sales guidance upward.