Has the Summer Stock Market Rally Peaked?

Key Points

• Major pullbacks in NVIDIA (NASDAQ: NVDA) and the VanEck Semiconductor ETF (NASDAQ: SMH) raise concerns about the summer rally peaking.
• The market is up nearly 15% year-to-date and 25% over the previous year, driven by advancements in AI and the impressive performance by a handful of tech giants.
• The market's narrow breadth, led by a few tech giants, suggests vulnerability to corrections and a need for sector rotation.

The stock market has been on a robust and impressive upward trend this year, with gains reaching nearly 15% year-to-date and close to 25% over the previous year. This strong performance in the SPDR S&P 500 ETF NYSE: SPY has been primarily driven by technological advancements, particularly in Artificial Intelligence (AI) and semiconductors.

Companies like NVIDIA NASDAQ: NVDA and other "Magnificent 7" members have been at the forefront of this rally. However, the market's overall gains would be much more modest without the technology sector and its titans. Recent market activity raises the question of whether the summer stock market rally has peaked.

Market Breadth Concerns: NVIDIA's Pullback Signals Trouble

One of the reasons for this concern is the significant pullback in NVIDIA, the market's leading stock. NVDA has fallen over 15% from its recent high, entering correction territory. The semiconductor sector, represented by the VanEck Semiconductor ETF NASDAQ: SMH, has also declined by almost 8% from its recent peak. This pullback may signal that speculative interest in the sector is waning as we approach the third quarter. Consequently, the overall market has dropped over 1% from its recent highs, predominantly due to NVDA's decline.

NVIDIA shares have now experienced three consecutive sessions of decline after briefly becoming the world's most valuable company last week. The stock has surged more than 140% this year and briefly surpassed Microsoft NASDAQ: MSFT in market value. The AI and chip giant has been a significant driver of the S&P 500's gains in the year's first half, contributing significantly to its recovery from late April lows.

For that reason, several analysts and market participants are now expressing concern about the market's narrow breadth, where only a few heavily weighted stocks are driving overall performance. Analysts at Morgan Stanley noted that market breadth is as narrow as it has been since 1965. This lack of breadth leaves the market vulnerable to corrections, as highlighted by Yardeni Research. They observed that while the S&P 500 has been reaching new highs, the percentage of companies trading above their 200-day moving averages has been falling, which could signal a looming correction.

Third Quarter Opportunities: Financials, Utilities, and Industrials Gaining Momentum

The "Magnificent 7" tech giants, including NVDA, Meta Platforms NASDAQ: META, Alphabet NASDAQ: GOOGL, and Amazon NASDAQ: AMZN, have all seen impressive gains. Meta has risen over 40%, Alphabet is up over 28%, and Amazon has surged over  22% YTD. However, relying on these few stocks for market gains raises concerns about market vulnerability. Maintaining the current market levels could be challenging if capital continues to flow out of leading tech stocks, such as NVDA.

Adding to these concerns, the price of Bitcoin, a highly speculative and volatile asset, has recently taken out near-term support and fallen significantly. Bitcoin has dropped nearly 13% over the past month and was trading near $60,000 at the time of writing. This decline further signals a decrease in speculative appetite, with capital potentially flowing towards more defensive sectors.

A potential solution lies in the rotation into other sectors, such as financials, utilities, and industrials, showing signs of significant moves in the third quarter. These more traditional sectors offer promising opportunities for investors looking to diversify. If these lagging sectors attract new inflows, the market might experience a healthy rotation, allowing it to sustain corrections in a few high-flying stocks like those in the semiconductor sector.

Q3 Strategy: Balancing Portfolios Amid Tech Sector Pullbacks

While the technology and semiconductor sectors have driven the market to impressive heights, recent pullbacks in key stocks like NVDA and a drop in speculative assets like Bitcoin have raised questions about the sustainability of the summer rally. Investors should monitor potential sector rotations and consider diversifying their portfolios to navigate possible market corrections as we move into the third quarter.