Has sector rotation caused earth-shaking changes in US stocks, or is it only a matter of time until the large technology companies reclaim their dominant position?

Earlier this month, large stocks such as Nvidia (NVDA) suddenly fell while small stocks, defensive stocks that are sensitive to interest rates, and value stocks such as finance rebounded.

Recently, indexes such as the small-cap Russell 2000 Index (RUT), the mid-cap S&P MidCap 400 (MID), and the value-oriented Dow Jones Industrial Average (DJIA) have outperformed the S&P 500 Index (SPX) and the Nasdaq Composite Index (IXIC) by the largest margin in many years, a phenomenon referred to as the "great rotation."

Since then, this situation has persisted to some extent. According to Dow Jones Market Data, as of Tuesday of this week, the Russell 2000 Index outperformed the S&P 500 Index by 10.8 percentage points, marking its best performance in recorded history for the last 10 days.

MarketWatch asked some market professionals what they are paying attention to and whether the beneficiaries of the recent "great rotation" can hold on to their recent gains or even go higher.

Here are a few things they believe investors should keep in mind.

Fed Rate Cut

The time for the transfer of market dominance to small-, mid-, and value stocks seems to have arrived as large stocks appear expensive.

However, Mike Reynolds, Vice President of Investment Strategy at Glenmede, believes that a real rotation needs a catalyst. The catalyst finally came after the release of the June CPI report on July 11, when investors raised their expectations for the number of Fed rate cuts next year.

According to data from the CME Group, traders now believe there may be as many as six rate cuts by August 2025.

Whether the Fed will actually make so many cuts could have a far-reaching impact on the trajectory of small-cap stocks at the end of this year. However, it is not just about the number of cuts. Why the Fed is cutting rates is also important.

Reynolds said in an interview on Tuesday, "The reason why the Fed cuts rates is very important. If the Fed cuts rates because of weakness in the economy, then small-cap stocks are more sensitive to the economy."

Corporate Earnings

Expectations for small-cap earnings growth have been rising, at least for the higher-quality components of the S&P SmallCap 600 Index.

According to Bank of America Global Research, the annual profit growth rate of stocks in this index will begin to exceed that of large-cap stocks later this year. This trend will continue until 2025. Without this optimism, small-cap stocks may not be able to maintain their positive momentum.

Bank of America expects that the trend of small-cap stocks outperforming large-cap stocks in terms of earnings growth will continue until 2025.

"To truly see any signs of a late-cycle non-cyclical sector in this market, we really need to see cyclical, value, and small-cap stocks confirm that earnings growth is expanding," said John Lynch, Chief Investment Officer at Comerica Wealth Management in an interview.

However, there may be many issues with the "great rotation" between now and then. If the tech giants in the "Fabulous Seven" and related stocks leave a deep impression on investors in their latest earnings reports, they could attract investors back to large-cap stocks. On the other hand, failing to meet the high standards set by Wall Street analysts can exacerbate sell-offs.

Is the profitability of the technology industry enough to regain investors' confidence?

Jason Draho, Head of Asset Allocation in the Americas at UBS Global Wealth Management, said in an interview, "Investors will be paying attention to the results of earnings reports and how they stack up against expectations."

Trump trade

Many stocks benefiting from rotation are also caught up in the 'Trump trade'.

Strategists say the Trump administration's policies seem to favor smaller companies that focus more on the domestic market.

Lynch believes that at the same time, Trump's tough talk on large tech companies, coupled with his trade protectionist agenda, may further harm many stocks benefiting from the AI boom.

Reynolds said that the policy positions of the new Democratic candidate are not yet known, which adds another layer of uncertainty.

Ultimately, this may depend on control of Congress. Alex McGrath, Chief Investment Officer of NorthEnd Private Wealth, believes that a divided Congress will be beneficial for maintaining the status quo.

McGrath said in an interview on Tuesday: "For us, this is the biggest unknown factor of all."

On Wednesday, due to the decline in technology stocks, both the S&P 500 Index and the Nasdaq Composite Index were dragged down, and the beneficiaries of the 'great rotation' seemed likely to continue to outperform the benchmark. The Dow and the E-mini Russell 2000 Index both fell, but not by much.