A Significant Shift In Market Dynamics

A potential rotation away from the Mag 7 tech stocks towards software and other growth-oriented assets

(1) What’s the buzz?

This week, a significant shift in market dynamics has caught the attention of investors, marking a potential rotation away from the traditionally dominant Mag 7 tech stocks and towards software and growth-oriented assets.

Mag 7 Underperformance

The Magnificent Seven, comprising tech giants like Microsoft, Amazon, Google, Nvidia, Apple, and Tesla (with some analyses excluding Tesla), have shown underperformance.

• For the second month in a row, the Mag 7 have underperformed the rest of the S&P 500, a trend that has not been seen consistently since 2023

• Individual stock performances were mixed but generally negative: Meta was down 3%, Amazon was down 7%, Microsoft was down 3%, Google was down 6%, and Nvidia was flat, while Apple and Tesla saw slight gains.

Software and Growth Stocks Surge

In stark contrast, software and cloud stocks have experienced a remarkable surge:

• The WCLD index, which tracks cloud and software companies, was up 6% over the last week.

• Snowflake saw a 30% increase after reporting solid earnings, lifting the entire software market.

• Other notable gains include Mongo, up 14%, Confluent, Datadog, and Cloudflare, each up 7%, and many others, rising close to 5%.

• Elastic reported a 20% stock rise after hours following its earnings report

Created with TradingView

(2) So what?

This shift raises questions about whether this is the beginning of a broader trend that will continue into 2025 or just a temporary fluctuation:

• The high valuations of the Mag 7, with PE ratios significantly higher than the rest of the S&P 500, may be contributing to their underperformance as investors seek more diversified and potentially undervalued opportunities

• The strong performance of software and cloud stocks could indicate a rotation into more risky assets, driven by optimism in sectors like cloud computing and artificial intelligence.

(3) Backing it up: Notable Quotes and Figures from the Report

The table below shows the top 10 Cloud and XaaS sector market movers in the last seven trading days.

The chart below compares the 7-day performance with the 30-day and YTD performance.

(4) Now what?

A significant shift appears to be emerging in market dynamics, with some evidence suggesting a potential rotation away from the Magnificent Seven tech giants towards broader software, cloud, and other growth stocks.

Market Rotation Analysis

The data shows remarkable strength in software stocks, with companies like C3 and Snowflake posting 33% gains in just seven days, while traditional tech leaders have faltered. The software sector's broad-based rally, demonstrated by solid performances across market caps (from Kaltura at $329MM to Snowflake at $57.4B), indicates this may be more than a temporary shift (such as the outperformance starting in July 2024, which faltered quickly).

Risk Appetite

The market appears to be seeking new opportunities beyond the established tech giants:

• Smaller, higher-growth software companies are seeing significant gains

• Companies with negative YTD returns (like Unity and BigCommerce) are showing strong recent performance

• The sector's average 30-day gain of 30% suggests increasing risk appetite

(5) And next?

The market's behavior suggests a natural evolution away from the concentrated Magnificent Seven trade that dominated 2022-2023.

This rotation could represent investors' search for new sources of alpha, recognizing that no single group of stocks can outperform indefinitely.

Small-cap and mid-cap stocks may be outperforming in the months ahead. Inside this group, small and mid-cap software and cloud stocks that have properly embraced AI and thus hugely benefit from the third stage of the AI revolution (the first was dominated by semiconductors, the second by broader AI infrastructure plys) may lead.

The strong performance across the hypergrowth software sector, particularly in companies with varying market caps and risk profiles, indicates a broader market appetite for growth opportunities beyond the established tech leaders.