Sam Stovall, chief investment strategist at CFRA Research, said rotational trading may not save the S&P 500 from future double-digit pullbacks. The stock market is going through a strange moment lately. Market laggards such as small-cap stocks have begun outperforming the broader market this year after cooling inflation data last week and dovish comments from Federal Reserve Chairman Jerome Powell strengthened the case for a rate cut in September. The small-cap iShares Russell 2000 ETF (IWM) is up more than 4% this week alone and is up 11% this year. On the other hand, large-cap technology stocks declined. This year’s market darling Nvidia is down 8% this week and is down about 15% from recent highs. IWM 1M mountain iShares Russell 2000 ETF (IWM) For many, the recent moves are a sign of a long-awaited rotation, which could mean further gains for the S&P 500 as the market expands away from artificial intelligence trading. But Stovall is skeptical, predicting a double-digit retracement for the S&P 500 in September. “I kind of doubt how long this is going to last,” Stovall said in a phone interview with CNBC. Expensive Valuations At the heart of the strategist’s concern is the overbought nature of large-cap tech stocks. Stovall noted that the S&P 500 trades at a 37% premium to its 20-year average price-to-earnings ratio, but technology stocks, which make up a larger share of the index, trade at a 75% premium. At the same time, he noted that the relative strength of cap-weighted technology compared with equally weighted industries has climbed to a 2,000-year high. “So there are a lot of things happening in large-cap stocks that suggest they are very expensive,” he said. What’s more, he said he doesn’t expect small and mid-cap stocks to have the power to lift the index if large-cap stocks underperform. Large-cap stocks account for more than 92% of the entire U.S. stock market, while small- and mid-cap stocks account for only 8%. “So, you think 92 percent is going to fit into less than 8 percent? I say that’s like you think you can drain one of the Great Lakes into your backyard swimming pool,” Stovall said. “Even the thought overwhelms me.” “Don’t back off.” Stovall said the ideal situation for investors is for the S&P 500 to trade sideways while small and mid-cap stocks outperform. . However, he said investors should prepare for a sudden downturn in the future. “If they have been thinking about taking profits in some of the large-cap space, which means they think some of the stocks are completely valued or overvalued, then take profits where possible. Move to small- and mid-caps or small- and mid-caps that are very attractive. Cap stocks. “But don’t back off. Because in a declining market environment, there’s almost no place to hide, which means everything is going to go down. They just go down to varying degrees,” he added.
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