Last Thursday, the e-mini Russell 2000 index skyrocketed by over 3%, while the S&P and Nasdaq both fell at the same time. According to Bespoke Investment Group's statistics, this situation where the Russell 2000 small cap stock index rose more than 3% and the S&P 500 large cap fell has only occurred once since 1979, the last time being on October 10, 2008. In terms of product structure, the operating income of 10-30 billion yuan products were 401/1288/60 million yuan respectively.

In addition, the Russell 2000 index has risen more than the Nasdaq in the past three trading days. According to media reports, similar situations have only been seen at important time nodes such as Lehman Brothers in October 2008, Trump's election in November 2016, and Biden's election in November 2020.

This has sparked speculation about sector rotation in the US stock market. As large-cap stocks continue to rise, Wall Street has been warning about risks, and hedge funds have been "voting with their feet." How far can sector rotation go and how will it affect investment?

What does the rare differentiation between large-cap and small-cap stock indexes in the US mean?

In the past period of time, the valuations of large technology stocks and AI concept stocks have been getting higher and higher, and a number of investment banks have begun warning of the risk of overheating and advising investors to balance their investments more. As expectations of a Fed rate cut bounce back, small-cap stocks, which are more sensitive to interest rates and the economy, have been seen as an excellent choice by Wall Street professionals.

Goldman Sachs Asset Management is bullish on the performance of small-cap stocks in the United States in the second half of the year because of their higher growth potential than mid- and large-cap top companies. At the same time, more industries will benefit from AI technology; the certainty surrounding the Fed's rate cut will also boost small-cap stocks. In addition, according to analysis by the bank, hedge funds, known as "smart money" on Wall Street, are accelerating their escape from the "AI bubble." Data shows that hedge funds have been selling TMT (technology + media + telecom) stocks for four consecutive weeks, and the low allocation ratio of TMT holdings is the lowest level hedge funds have had for TMT stocks since records began.

So, will the "large-cap to small-cap shift" in the US stock market happen now? GF Securities summarizes the two major reasons for the flourishing period of small-cap stocks in the US stock market in the past 50 years-- the low base effect and the catalysis of emerging industries. The low base effect refers to an economic phenomenon where the year-on-year growth rate looks higher due to the lower value of certain indicators in the previous year, and under this scenario, small-cap stocks have greater profit recovery elasticity. In addition, opportunities for incremental development arise from policies, industries, or trade environments.

Will US sector rotation occur, and how to adjust investment portfolios?

The trend of small-cap stocks in the US stock market is often seen as an indicator of the potential for interest rate easing and an economic indicator. The reason for the outbreak of the Russell 2000 index in this round is twofold. First, compared to mid- and large-cap stocks and technology giants, small-cap stocks have larger valuation recovery space after two years of silence. Second, the direct catalyst is the expectation of a rate cut.

After the CPI's unexpected cooling last Thursday and Powell's dovish remarks this week, betting on a rate cut later this year has increased significantly. According to CME's "Fed Watch," the probability that the Fed will maintain interest rates unchanged until September has fallen to 0, and the probability of a rate cut in July has begun to rise.

According to data from the CBOE (Chicago Board Options Exchange), demand for call options on the Russell 2000 index and its ETF has surged in the past several trading days since Thursday, indicating that the index may continue to rise.

Similar situations have occurred in the fourth quarter of last year, when bullish sentiment for small-cap stocks reached extreme levels due to the rapid rise in expectations of a rate cut, and the Russell 2000 index rose more than 20% between early November and early December, outperforming the S&P and Nasdaq during the same period.

According to Tom Lee, head of research at Fundstrat, small caps could rise by 50% by 2024, indicating a large upside compared to current levels. His analysis found that small businesses are often more sensitive to borrowing costs. With the Federal Reserve stopping interest rate hikes at the end of last year, this has led to a rapid rise in Russell 2000 and will be a great bullish factor for small caps. In addition, investor confidence in regional banks is improving, and the financial industry accounts for a large proportion of about 15%.$iShares Russell 2000 ETF (IWM.US)$In the first half of the year, with AI booming globally, the trend of US large cap indexes was almost completely dominated by technology giants. But if bond yields continue to decline as interest rates are priced, the entire stock market's valuation will become extremely attractive. If sector rotation comes, how should investment portfolios be adjusted?

To reduce the risk of sharp rotation from large cap stocks to small cap stocks, Bank of America recommends holding call options as hedging tools, including:

Call options for Nasdaq 100 index as a hedge;

• $Russell 2000 Index (.RUT.US)$,$iShares Russell 2000 ETF (IWM.US)$Call options for Bank of America as a hedge for the S&P 500 index (market-weighted).

• $Invesco Exchange Traded Fd Tr S&P 500 Equal Weight Etf (RSP.US)$In addition to options, the layout of other small-cap ETFs in the U.S. stock market is also very active. From the perspective of trading activity,

is a leader in this sector, followed by iShares (IJR.US);$iShares Russell 2000 ETF (IWM.US)$It's worth noting that small caps have a higher volatility and lower weighting in the technology sector. Investors should be especially cautious of investment risks.$iShares Core S&P Small-Cap ETF (IJR.US)$Second in command;

Other leveraged small cap stock ETFs include:

$Proshares Trust Pshs Ultruss2000 (UWM.US)$,$Short Russell 2000 Proshares (RWM.US)$

$Direxion Daily Small Cap Bull 3X ETF (TNA.US)$,$Direxion Daily Small Cap Bear 3X Shares ETF (TZA.US)$

It is worth noting that small caps have a higher volatility and lower weighting in the technology industry. Investors need to pay special attention to investment risks.

There are plenty of index ETFs available for investors to choose from in the U.S. stock market. Mooers can click on the following link to see more details:Market > ETF > US stock market > Index ETFClick here to view.

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