The remarkable rise of the American stock market that marked five consecutive months of gains has come to an abrupt halt as we entered the second quarterRenewed concerns surrounding inflation and the delay in expected interest rate cuts from the Federal Reserve have dented investor risk appetites dramatically.

Yet, despite these challenges, the technology sector has showcased resilience, absorbing the pressures of renewed selling and demonstrating a vigorous revivalThis sector, buoyed by returning buyer interest, has led the major indexes in stabilization and recovery as summer approachesIn stark contrast, small-cap stocks continue to struggle, burdened by economic uncertainty.

Leading the charge this quarter has been the robust performance across the tech sectorsBefore the start of the earnings season, the market was under a cloud of worries regarding Federal Reserve rates and economic prospects

However, as companies released their financial results, investor sentiments shifted, revealing that these concerns may have been overstatedAccording to data provided by the London Stock Exchange Group (LSEG), profits for S&P 500 companies grew by 7.1% last quarter, significantly outperforming the estimated growth of approximately 5% noted at the beginning of April.

One of the standout performers this quarter has been the broader technology sectorNotably, the communication services sector has reported a striking year-on-year profit growth of 43.5%, marking its third consecutive quarter exceeding the 40% thresholdAdditionally, tech giants like Nvidia, Apple, and Microsoft have recorded an impressive growth rate of 23.8%. These two sectors have played pivotal roles in revising the market’s overall earning projections upwards.

Recent earnings reports from prominent firms including Amazon, Microsoft, and Google’s cloud division demonstrated formidable growth in the first quarter, sending a positive signal to the $270 billion cloud computing industry

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Companies have begun to restore their spending in this regard, leading the stocks of these three tech giants to surge once more toward their historic highs.

Boris Schlossberg, a strategist at BK Asset Management, shared insights with reporters noting that the earnings releases from Microsoft and Google reignited investor confidence in artificial intelligenceHe believes that major projects will soon herald a healthy capital spending cycle.

Indeed, recent fund flows corroborate this narrativeAmazon Web Services (AWS) reported a remarkable revenue growth of 17% in the first quarter, culminating in its annualized revenue reaching the $100 billion benchmark for the first timeMicrosoft Azure and Google Cloud also posted impressive results, with year-on-year growth figures for the first three months standing at 31% and 28%, respectivelyGil Luria, an analyst at D.ADavidson & Co., observed that across AWS, Microsoft Azure, and Google Cloud, two phenomena are occurring simultaneously: the contributions of artificial intelligence to growth and an acceleration in cloud spending.

In recent years, the demand for cloud infrastructure has skyrocketed, exhibiting an annual growth rate of 60% as businesses transition more of their operations online

Satya Nadella, CEO of Microsoft, noted in a recent earnings call, “The number of customers utilizing Azure AI continues to grow, with expenditures on average on the riseAI services have contributed to 7% of Azure's growth, an increase from 6% in the previous quarter.”

Similarly, Sundar Pichai, CEO of Alphabet, highlighted in communication with institutional analysts that over 60% of generative artificial intelligence startups and nearly 90% of generative AI unicorns utilize Google Cloud.

Conversely, small-cap stocks, typified by the Russell 2000 index, have consistently lagged behind the top three major indexesAs the Federal Reserve has postponed its plans for rate cuts, the uncertainty surrounding the economy has cast a long shadow over small-cap stocks.

Recent data from the Institute for Supply Management (ISM) indicated that the U.Sservice sector has ended its streak of expansion that began in December 2022. Anthony Nieves, chair of the ISM’s Services Business Survey Committee, commented on the composite index's decline in April, attributing it to a decrease in business activity, a slowdown in new order growth, accelerated supplier deliveries, and continued contraction in employment.

Furthermore, the labor market shows signs of loosening when considering non-farm payrolls and job vacancy indicators

Schlossberg remarked to reporters that a slowdown in the U.Seconomy appears evident, yet inflation is not progressing toward the anticipated 2% target as expected“While Fed Chair Jerome Powell has dismissed concerns regarding stagflation, the prospects for a soft landing are clearly less optimistic than before,” he noted.

The Russell 2000 index had initially surged toward the end of 2023 as investors bet that the Federal Reserve had completed its rate hikes and would soon pivot to easing monetary policyThis outlook would have been a welcome change for smaller companies which typically rely more on debt financing and consumer spendingHowever, persistent inflation has shattered these investor hopes; the Russell 2000 index has only managed a meager 0.4% increase year-to-date, falling significantly behind its larger-cap counterparts.

Michael Arone, chief investment strategist at State Street Global Advisors’ SPDR Business, added that investor sentiment towards small-cap stocks is now cautious, stressing that clearer indications are needed from the Federal Reserve regarding potential rate cuts before any action is taken

Futures markets indicate that the Federal Reserve’s interest rate easing is anticipated to be limited to around 40 basis points this year, a stark contrast to the six rate cuts priced in at the beginning of the year.

The valuation landscape for small-cap stocks is also less favorableAccording to LSEG data, the estimated earnings growth rate for the Russell 2000 constituents in the first quarter is expected to lag nearly 2% behind that of the S&P 500 indexMoreover, the forward price-to-earnings ratio for the Russell 2000 index stands at 22 times, compared to 20 times for the S&P 500 index, rendering small-cap stocks appear relatively more expensive.

David Lefkowitz, chief investment officer for U.Sequities at UBS Global Wealth Management, commented on the disillusionment with small-cap earnings recovery, stating, “The expected resurgence in small-cap earnings has not materialized.” While he began accumulating small-cap stocks last December, he still believes there is a rationale for favoring small companies, contingent on the Federal Reserve’s views on interest rates.

Lastly, Jill Carey Hall, a strategist at Bank of America Global Equity and Quantitative Strategy, advised investors to focus on small-cap companies that can withstand a protracted period of elevated Federal Reserve rates