Is it all over for growth stocks?

Is it all over for artificial intelligence-related plays? AI market leader NVIDIA reported stronger-than-expected quarterly results, and CEO Jensen Huang characterized demand for its Blackwell chip as “off the charts”. The stock staged a brief reflex rally but the price faded the next day to close in the red.
Even as the market adopted a risk-off tone, market leadership showed a clear growth to value rotation across the board on all market cap bands and internationally. Is it all over for growth stocks?
 

 

I analyzed the market through the lens of leadership rotation, and here’s what I found.
 

 

A Sector Leadership Review

My primary tool for market leadership analysis is the RRG chart. Relative Rotation Graphs, or RRG charts, are a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotate to lagging groups (bottom left), which change to improving groups (top left), and finally complete the cycle by improving to leading groups (top right) again.

A conventional RRG chart of S&P 500 sectors shows a curious pattern. There were no sectors in the top right leading quadrant. Technology had rotated from the leading to weakening quadrant. While the typical rotation pattern calls for it to eventually move to the lagging quadrant in the bottom left, its tight clockwise rotation may put it back up to the leading quadrant.

A scan of the improving quadrant reveals the up-and-coming sectors consisting of energy, healthcare and utilities. These are sectors with individual idiosyncratic characteristics that don’t fit into a conventional value-growth or risk-on/off narrative.
 

 

An analysis of the equal-weighted S&P 500 sectors against an equal-weighted S&P 500 tells a slightly different story. Equal-weighted minimizes the effects of the weight of the Magnificent Seven in the index, and can reveal useful patterns beneath the hood.

As the accompanying chart shows, equal-weighted technology remains in the top right leading quadrant, and the emerging leadership of energy, healthcare and utilities is more prominent.
 

 

 

Emerging Leadership

An analysis of improving sectors from the RRG charts shows that the emerging leadership candidates each have their own idiosyncratic risk and return patterns. Utilities stocks bottomed in April and they have been in an uptrend. The relative return chart shows a saucer-shaped bottoming pattern. Relative breadth (bottom two panels) has also been strong.

That’s positive, right? But utilities are a hybrid AI play based in the expectation of rising electricity demand from data centres.

Should the strength of utilities be interpreted as bullish for AI exposure and a growth sector or bearish because of its defensive characteristics?

 

Healthcare stocks are enjoying a recovery from a multi-year capitulation and washout. The sector has rallied to test a major resistance level, though it did stage a relative breakout (second panel), which is promising. While the sector has a promising intermediate-term outlook, price action appears extended in the short run.
 

 

Energy is another sector with signs of emerging leadership. It’s been in an uneven uptrend since April and its relative return chart shows a promising saucer-shaped bottom pattern. Relative breadth has also been strong.
 

 

However, the outlook on the sector depends on the oil prices, which have been in a downtrend but on the verge of testing support at the $60–$62 zone.
 

 

 

Factor and Macro Leadership

Investors can use RRG charts for different perspectives of market behaviour. The accompanying chart analyzes factor leadership against an equal-weighted S&P 500. As the chart shows, leading and improving factors can be characterized as value and fundamentally driven factors, namely large-cap value, quality, dividend growth and low volatility. By contrast, the factors in the bottom half of the chart can be characterized as high-octane factors, such as price momentum, speculative growth, high beta, IPOs and large-cap growth.

Viewed against such a prism, this foreshadows a period of sloppy price action or correction.
 

 

For a top-down macro perspective, the accompanying chart shows rotation analysis of selected asset classes against a U.S. 60/40 benchmark. From that perspective, equities are weakening in all regions, with the exception of EM Ex-China. U.S. equities fell from the top-right leading quadrant to the bottom right weakening quadrant. The most prominent market leaders are commodities and gold, followed by bonds in the improving quadrant.
 

 

That said, investors shouldn’t just accept these results without some degree of cross-asset analysis. The strength in gold and commodities is partly attributable to recent USD weakness. As well, EM ex-China stocks have also shown an inverse correlation to USD movements.
 

 

In addition, Dhaval Joshi at BCA Research pointed out that the NASDAQ is highly sensitive to real interest rates. This makes the FOMC December decision an enormous wildcard in the short-term outlook for stock prices and value-growth outlook.
 

 

In the absence of official economic data, hawkish Fedspeak from regional Fed Presidents, and indications of a divided committee from the latest FOMC minutes, the December rate decision will be a close call. However, the news that New York Fed President John Williams would back another rate cut is an indication that the Fed leadership will be trying to build a consensus for a cut. As a consequence, the market derived odds of a December cut rose from about 40% on Thursday to over 70% Friday.
 

 

In conclusion, a market leadership review shows a gradual rotation from growth to value leadership, and from high-octane momentum names to fundamentally driven investment factors such as quality and dividend growth. However, macro factors such as the possibility of Fed easing and short-term technical rotation patterns raise the odds of a growth rebound.

Finally, I leave you this dot-com era bubble analog from Jurrien Timmer at Fidelity. With the exception of the Russia and LTCM Crisis, the current market is tracking the analog fairly well. With the caveat that the magnitude of the returns are not as large (bottom panel), we are somewhere in early 1999. I interpret this to mean that the market is undergoing an AI bubble, but it’s not over just yet.