Market Leadership Rotates as Small Caps Gain and Tech Slips

Executive Summary 

Major U.S. stock indexes closed the week mixed as concerns about artificial intelligence related spending and financing weighed on large-cap technology shares, while small-cap and value-oriented stocks outperformed amid a rotation in market leadership. The small-cap Russell 2000 Index led the major benchmarks, advancing 2.0%. However, the Nasdaq Composite and S&P 500 Index declined 0.7% and 0.5%, respectively. In the large-cap universe, value stocks outpaced growth for the third consecutive week. 

Oil prices moved higher late in the week amid reports of renewed tensions in the Middle East, reversing earlier declines tied to optimism surrounding U.S.-Iran diplomatic discussions. 

U.S. Treasury yields decreased sharply during the week as the sell-off in technology stocks and heightened geopolitical uncertainty contributed to stronger demand for U.S. government securities. (Bond prices and yields move in opposite directions.) The benchmark 10-year Treasury yield fell below 5% for the first time in about a month on Thursday, settling around 4.99% by Friday afternoon. 

France is facing growing pressure in its bond market as concerns about its finances and political uncertainty test foreign investors’ appetite for its debt. The yield on the government’s 10-year bonds, for example, rose to more than 5%, resulting in the widest yield spread since 2012 versus German bonds of equivalent maturity.  Nearly 55% of French government debt was held outside the country last year, compared with 31% in the US and 13% in Japan. With 10-year French bond yields now above 5% for the first time since 2002, that reliance could prove costly: France has more than $1 trillion in debt coming due by 2030.  The pan-European STOXX Europe 600 Index ended the week down 1.4% in local currency terms. 

A weakening housing market and stable to softening labor market are likely to provide deflationary pressures to the economy.  Last week, the National Association of Home Builders reported that its Housing Market Index, pending home sales declined and housing starts also weakened from the prior month. 

Finally, last week’s labor market data were more encouraging. Initial jobless claims came in at 194,000 for the week ended October 17, down from the prior week's revised reading of 200,000 and the lowest level since July. Continuing claims, however, increased by 25,000 to 1.7 million. 

Key Takeaways 

1. The housing market continues to weaken as high mortgage rates weigh on buyers and builders.

Pending home sales, which measure contracts to purchase existing homes, fell -7.3% in September, with the index at its lowest level since tracking began in 2001. Housing starts declined -5.2% in September to an annualized rate of 1.22 million units, the second weakest reading since the pandemic. Homebuilder confidence fell to 29 in October, its lowest level since 2012 and well below the neutral level of 50. The weakness is tied to the average 30-year fixed-rate mortgage being above 7%, which is among the highest levels since the early 2000s. High borrowing costs and persistent affordability challenges have discouraged buyers, while elevated construction costs have weighed on builders, leading them to reduce prices and offer incentives to attract buyers.

Implication

The breadth and severity of the latest declines underscore how much housing has weakened relative to other areas of the U.S. economy and provides a deflationary force against higher oil prices and Tariffs which push prices up across the economy.  

2. Industrial production increased in September, although underlying manufacturing growth remained concentrated in technology-related industries.

Headline industrial production rose +0.7% for the month, helped by a +3.5% increase in utility output tied to unseasonably high temperatures and increased demand for electricity and natural gas. Meanwhile, manufacturing output increased by a more modest +0.3%. Looking at the full third quarter, semiconductor and electronic-component production grew at a +28.4% annualized rate, helping support manufacturing activity. However, manufacturing output excluding selected high-technology industries was nearly flat, increasing at just a +0.1% annualized rate.

Implication

Technology-related manufacturing continues to support industrial growth, while activity across the broader manufacturing sector remains more modest. 

3. Import and export prices rose sharply in September, providing further evidence of broadening inflation pressures.

Prices for goods imported into the U.S. increased +1.1% for the month and +8.1% over the past year. While higher fuel prices contributed to the increase, import prices excluding fuel also rose +0.7%. In addition, prices received by U.S. exporters increased +2.2% for the month and +11.6% over the past year. These figures reflect prices paid and received in international trade rather than prices charged directly to consumers.

Implication

The report adds a business-level perspective to last week's consumer and producer inflation data, providing further evidence of the breadth of September's price increases. 

4. The S&P 500 remained near record highs despite considerable volatility beneath the surface.

Large technology companies, particularly those tied to artificial intelligence and semiconductors, have experienced sharp swings in recent weeks. However, other sectors, including some that had previously lagged the broader market, have partly offset the weakness in technology and AI companies.

Implication:

Recent market volatility has largely reflected changes in leadership rather than a broad-based retreat from stocks.