Investors Rotate to RSP From SPY as Inflation Cools

Thursday’s cooler-than-expected CPI report sparked a furious rotation in the stock market. 

The SPDR S&P 500 ETF Trust (SPY) was lower by 0.8% midday, which may appear a perplexing reaction to good news on inflation.

But SPY had rallied sharply leading up to the release of the CPI data, sporting a stunning 19% year-to-date return as of Wednesday.

Mega cap tech stocks, in particular, like Nvidia, Microsoft, Apple and others had soared in recent sessions, so a bit of profit taking—“sell on the news”—may not look surprising to investors.

Combined with rising expectations of a Fed rate cut in September and following June’s benign inflation data, investors have a recipe for taking money out of what’s been working and putting it into cheaper, economic-and-interest-rate-sensitive stocks that hadn’t rallied nearly the same amount.

The Invesco S&P 500 Equal Weight ETF (RSP), a proxy for the 450-plus stocks that aren’t among the Magnificent Seven and the wider cohort of megacap stocks, was last trading up by 1.2% midday.

Fierce Rotation

The 200-basis point difference between the daily return of SPY and RSP is the largest since November 2020, illustrating the ferocity of the rotation from megacap into smaller stocks. 

RSP was up only 5.5% year-to-date versus 18.9% for SPY at the close of Wednesday, so a bit of a catch up trade is in the works today.

As of midday, the gap had narrowed to 17.9% versus 6.7%, still wide by any measure. Perhaps more evidence that the Fed’s first rate cut of the cycle is coming will help close that spread further, though working against that is the excitement surrounding the AI boom, which is a positive catalyst for megacaps.