Market strategist: 'It's a good point in time to take a deep breath'

·3-min read

After having their worst start to the year ever, tech and small-cap stocks are starting to show signs of life.

A shift in the market began to take hold in late June, leading to an increase of 9.11% in the S&P 500 in July. That same month, the Nasdaq (^IXIC), comprised of primarily technology stocks and small-cap companies, outpaced the S&P 500 (^GSPC), posting a gain of 12.3%.

Because of that, advisors are returning to previously battered areas of the market, like technology.

"It's a good point in time to take a deep breath and say: Are those companies ever going to come back?" VettaFi Vice Chair Tom Lydon said on Yahoo Finance Live (video above). "Did I not have them? Did I sidestep them? As we look forward and maybe the prognosis for the markets and the economy, although it's not as great as it used to be, is it somewhat stable? Is it a buying opportunity? Just by the flows that we're seeing in areas like technology stocks, like small-cap stocks, advisors and individual investors have taken advantage of it."

A combination of interest rate hikes by the Federal Reserve, record levels of inflation, and supply chain woes had put the market into a volatile tailspin since its peak at the end of 2021.

Now, with the Fed providing more transparency on rate hikes, coupled with investors thinking that inflation may be easing, many have returned to beaten-down areas of the market for the potential return on investment.

“A year ago, they were really concerned about inflation, number one," Lydon explained. "Number two, rising interest rates. And geopolitical risk was kind of a distant third. Fast forward to today — not as concerned about inflation. It's still high, but not as hot as it was a year ago. Rising interest rates, to a great degree, are baked in. And geopolitical risk, well, it's always going to be a part of it.”

Lydon cited Cathie Wood's ARK Innovation ETF (ARKK) as a prime example of the rebound in tech stocks. In the last six weeks, the ETF was up 30-35% after a huge decline of 60-70%.

Small-cap tailwinds

As earnings season continues, the biggest surprise, according to Lydon, has been the performance of small-cap stocks.

Small-cap companies — which are defined as having a market capitalization of between $300 million and $2 billion — don't face the same global economic headwinds that large-cap companies like the FAANG names do, Lydon highlighted.

"Although small caps are a little bit more nimble than large caps, they focus on domestic business, mostly," he said. "And with the huge move in the U.S. dollar, we've seen that small-cap companies have taken advantage of that. They're able to buy services and also products overseas, bring them here for a lesser price. And they don't sell as much overseas, which would be more expensive for overseas buyers."

Traders work on the floor of the New York Stock Exchange during morning trading on July 13, 2022 in New York City. (Photo by Michael M. Santiago/Getty Images)
Traders work on the floor of the New York Stock Exchange during morning trading on July 13, 2022 in New York City. (Photo by Michael M. Santiago/Getty Images)

Nearly three out of four small-cap stocks have outperformed on both the top and bottom lines, Lydon noted, signaling there's even more opportunity.

"With the ability to put their foot on the gas if things start to look better, they can really ramp up a lot quicker," he added. "It's nice to see the big mega caps start to bounce back as well. But at this point in time, when we've had a bit of a pullback, a lot of smart investors are trying to pick their spots. Where can they put that dry powder back to work?"

Ethan is a writer for Yahoo Finance.

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