As the Federal Reserve begins its rate-cutting cycle, the "leading rise myth" of tech giants may come to an end

According to the Zhitong Finance APP, the strategist team led by Savita Subramanian, head of U.S. equity market strategy and quantitative investment strategy at the Wall Street financial giant Bank of America (BofA), recently stated that the "U.S. Regime Indicator" compiled by Bank of America recorded its largest jump in over a year in July, which also signifies that the indicator has sent a significant potential signal of a shift in the U.S. business cycle fundamentals from a "downturn" to a "recovery."

In the view of the Bank of America strategy team, during previous business cycle recovery phases, the so-called "not-so-Nifty 450" (the remaining 450 stocks in the S&P 500 excluding the 50 super large-cap stocks, also known as the "not-so-pretty 450") experienced a price-to-earnings (P/E) expansion that was about twice that of the "Nifty 50" (the so-called "pretty 50 index").

According to Bank of America's self-built index classification, the "Nifty 50" consists of the top 50 stocks in the S&P 500 ranked by market capitalization (a BofA-defined group), which is rebalanced monthly; it has both market-cap weighted and equal-weighted versions. The "Not-so-Nifty 450" consists of the remaining 450 stocks in the S&P 500 (the 450 stocks ranked after the top 50), which is also rebalanced monthly and provides both market-cap weighted and equal-weighted versions.

Will the "not-so-pretty 450" soon completely outperform the "pretty 50"?

This proprietary tool from Bank of America, designed to measure the current stage of the U.S. business cycle—the "U.S. Regime Indicator"—has shown a significant momentum shift that has attracted the attention of global market strategists. The team led by Bank of America strategist Subramanian stated, "The continued signs of improvement in August will be an early confirmation signal of the cycle shifting from downturn to recovery."

Moreover, Bank of America strategists emphasized that after achieving two consecutive months in the new regime state, this shift will become more "official." Historical data shows that during previous U.S. business recovery periods, the "pretty 50" (Nifty 50) underperformed the benchmark by about 3.3 percentage points per year, and they only outperformed during 36% of the recovery periods. In comparison to the remaining 450 stocks ("not-so-pretty 450"), the largest top 50 stocks (the "pretty 50") lagged behind them by an average of 3.3 percentage points per year during U.S. business recovery periods.

Bank of America's retrospective data also indicates that during past recovery periods, the overall P/E expansion of the "not-so-Nifty 450" index was indeed twice that of the overall P/E of the "pretty 50" index.

The Bank of America strategist team stated that under the "recovery" framework of the "U.S. Regime Indicator," funds are more likely to overflow from the most crowded seven tech giants, driving a much stronger valuation repair and relative return recovery for the "remaining 450" in the S&P 500; historical data shows that the so-called "Nifty 50" (pretty 50) lagged behind by about 3.3 percentage points per year on average during this cycle, and only 36% of recovery periods were able to outperform them Bank of America’s market capitalization analysis shows that from March 2015 to the present, the market-capitalization-weighted S&P 500 Index (SP500) has significantly outperformed its equal-weighted version (RSP), with the former rising by 161% and the latter by about 81%. At the same time, the "Fabulous 50" has outperformed the smallest 50 stocks in the S&P 500 Index by 403% on an equal-weight basis.

Despite the unprecedented AI boom, driven by the soaring large-cap stocks like Nvidia, Microsoft, and Google, which hold substantial weight in the S&P 500 Index and continue to benefit from the AI surge, the gap in performance between large-cap and small-cap stock benchmarks in the U.S. has reached its largest scale in over thirty years, possibly indicating that the leading position of large-cap stocks may continue.

The so-called "Magnificent Seven," which occupy a significant weight (about 35%) in the S&P 500 Index and the Nasdaq 100 Index, includes Apple, Microsoft, Google, Tesla, Nvidia, Amazon, and Facebook's parent company Meta Platforms. They are the core drivers behind the S&P 500 Index reaching new highs.

Long-term statistics dating back 30 years show that the indicators measuring the performance of small-cap tech stocks are lagging behind those measuring the performance of large tech giants by the largest margin in history. Year-to-date, U.S. tech giants Microsoft and Nvidia have risen by 24% and 36%, respectively, with both companies' market capitalizations surpassing $4 trillion. Nvidia ranks first in the global market capitalization leaderboard, followed closely by Microsoft, ultimately driving the large-cap tech index in the U.S. stock market up by 16%, while the small-cap tech index has declined by 1% since 2025.

Looking at the entire U.S. stock market, the seven tech giants have been the strongest engine driving the market since 2023. They attract global capital with their strong market advantages, robust revenue from AI, solid fundamentals, years of strong free cash flow reserves, and expanding stock buyback programs. However, the historically high valuations of these giants have made Wall Street increasingly cautious—six of the seven tech giants are expected to have price-to-earnings ratios above 25x, which is the valuation of the S&P 500 Index, while the valuation of the large-cap benchmark—the S&P 500 Index—is also near historical highs.

However, based on historical data and market trading logic, Bank of America strategists believe this trend may be nearing its end. The team led by strategist Subramanian stated, "If the Federal Reserve's next move is to cut interest rates, and our Regime indicators are shifting to 'recovery,' we believe this super bull market for large-cap stocks may be closer to its end." "This potential significant shift means major implications for investors heavily invested in large-cap tech stocks (IYW)."

When the Federal Reserve begins its interest rate cut cycle, will the time for the "not-so-pretty 450" and the rise of mid and small caps arrive?

Research shows that the improvement in Bank of America's "Regime indicators" is broad-based, with six out of eight original inputs showing positive changes in July. Strengthening factors include upward revisions in earnings per share (EPS), inflation, GDP forecasts, 10-year U.S. Treasury yields (US10Y), capacity utilization, and high-yield bond spreads However, strategists such as Subramanian pointed out in the report that leading economic indicators and the ISM Purchasing Managers' Index have weakened during the same period.

Since February 2022, this indicator has fluctuated between different business cycle phases, primarily due to the severe volatility of macro signals. According to Bank of America strategists, the significant fluctuations in recent years stem from the "repeated whip effect of inventory and demand—first from the negative impacts of the COVID pandemic on the economy and supply chains, and this year from the market's anticipation of progress on Trump tariffs."

Despite some historical inconsistencies, the strong reversal performance of several current input items indicates that the signals of this business cycle recovery are more sustainable than the previous "false start" cycle signals, although strategists remain cautious about declaring a clear trend.

Bank of America strategists stated that as the market becomes increasingly cautious about the valuation of the seven major tech giants in the U.S. stock market (the Magnificent Seven), coupled with recent economic data indicating that a "soft landing" for the U.S. economy is becoming more likely, and with interest rate futures traders betting on the possibility of two rate cuts by the Federal Reserve starting in September this year, small and mid-cap stocks (especially micro-cap stocks) are currently facing structural opportunities. However, it is necessary to focus on high-quality factors and low-risk factors to hedge against economic downturn risks, while avoiding high-leverage consumer stocks and high-risk tech stocks that have not yet achieved breakeven in the small and mid-cap space.

If the Federal Reserve's rate-cutting cycle officially begins and the U.S. economy demonstrates resilience to achieve a "soft landing," the upward momentum of U.S. stocks is likely to continue rotating to those stocks outside the seven major tech giants that have long underperformed since 2022, referred to as the "not-so-pretty 450," as well as small and mid-cap stocks. From an investment theory perspective, these stocks are extremely sensitive to the Federal Reserve's interest rate expectations, and even a slight rate cut is expected to improve their battered prices and valuations, especially for high-quality small and mid-cap stocks supported by performance. The backdrop of the Federal Reserve's rate cuts means that the long-standing debt pressure on these companies will significantly decrease, thereby potentially improving profit margins and stock valuations.

Below are the stocks compiled by Bank of America strategists from the S&P 500 Index (with stock codes in parentheses), which have a forward P/E ratio below the median, a Beta above the median (>1 indicates higher volatility than the U.S. stock market, <1 indicates much lower than the market), and a market capitalization below the market median, while receiving a "buy" rating from Bank of America analysts. These stocks are also core recovery narrative targets of the "not-so-pretty 450" index:

United Airlines (UAL) – Forward P/E: 7.7; Beta: 1.3

Devon Energy (DVN) – Forward P/E: 8.0; Beta: 1.1

Host Hotels & Resorts (HST) – Forward P/E: 8.1; Beta: 1.2 Delta Air Lines (DAL) – Forward P/E: 8.4; Beta: 1.4

Synchrony Financial (SYF) – Forward P/E: 8.4; Beta: 1.3

Aptiv (APTV) – Forward P/E: 8.9; Beta: 1.3

Healthpeak Properties (DOC) – Forward P/E: 9.0; Beta: 1.1

First Solar (FSLR) – Forward P/E: 9.0; Beta: 1.3

Halliburton Co. (HAL) – Forward P/E: 9.1; Beta: 1.1

Eastman Chemical Co. (EMN) – Forward P/E: 9.3; Beta: 1.2

BXP (BXP) – Forward P/E: 9.3; Beta: 1.1

PulteGroup (PHM) – Forward P/E: 9.6; Beta: 1.2

Hewlett Packard Enterprise Co. (HPE) – Forward P/E: 10.0; Beta: 1.3

KeyCorp (KEY) – Forward P/E: 11.1; Beta: 1.1

Steel Dynamics (STLD) – Forward P/E: 11.2; Beta: 1.3

Mohawk Industries (MHK) – Forward P/E: 11.4; Beta: 1.2

Expedia Group (EXPE) – Forward P/E: 11.5; Beta: 1.4

Mosaic Co. (MOS) – Forward P/E: 12.5; Beta: 1.1

Federal Realty Investment Trust (FRT) – Forward P/E: 12.6; Beta: 1.1

Lululemon Athletica (LULU) – Forward P/E: 13.3; Beta: 1.1

Smurfit Westrock (SW) – Forward P/E: 13.6; Beta: 1.1

Western Digital (WDC) – Forward P/E: 14.1; Beta: 1.4 Nucor Corp. (NUE) – Forward P/E: 14.5; Beta: 1.5

IQVIA Holdings (IQV) – Forward P/E: 14.9; Beta: 1.2

Northern Trust (NTRS) – Forward P/E: 15.2; Beta: 1.2

Regency Centers (REG) – Forward P/E: 15.3; Beta: 1.0

Seagate Technology (STX) – Forward P/E: 15.7; Beta: 1.3

International Flavors & Fragrances (IFF) – Forward P/E: 16.0; Beta: 1.0

Weyerhaeuser (WY) – Forward P/E: 16.7; Beta: 1.1

Dover (DOV) – Forward P/E: 18.4; Beta: 1.2