The Stock Market Is Betting on Big Tech and Rate Cuts, Not the Economy

Stocks are getting a boost from rate cut bets. That might not be good news. (TIMOTHY A. CLARY/AFP via Getty Images)

The S&P 500 hit a fresh high Tuesday, extending the benchmark’s annual gain closer to 10% as investors added to bets on a near-term interest rate cut from the Federal Reserve following a well-received inflation report.

Digging deeper into the July numbers, investors are also finding some evidence of stagflation risks in the world’s biggest economy that could test the market’s impressive rally heading into the autumn months.

Core consumer price pressures, which strip out volatile components like food and energy, rose at an annual pace of 3.1% last month, the quickest since February, according to data from the Bureau of Labor Statistics. Goods prices eased, however, suggesting the pass-through from tariffs isn’t as powerful as it was in late spring and early summer.

That is likely to provide Federal Reserve Chairman Jerome Powell, who remains under intense pressure from the White House, just enough wiggle room to lower borrowing rates for the first time since December when the central bank meets next month in Washington, D.C.

“Those looking for a meaningful influence on consumer prices from tariffs in July were largely chasing shadows,” Jason Pride, chief of investment strategy and research at Glenmede, said about the July CPI report. “This is another piece of incremental information making the case for a September rate cut.”

Tech stocks, once again, led the session’s advance, with the Nasdaq Composite rising more than 1.3% and the biggest names in the artificial intelligence sector powering the S&P 500 to a 1.1% gain.

The paradox found in surging stocks and quickening inflation data should remind investors that index gains aren’t an indication of economic strength.

“Investors must come to grips with inflation above the Fed’s target amid a backdrop of slower growth, setting things up for stagflation-lite,” said Jeffery Roach, chief economist for LPL Financial in Charlotte. The Fed has a goal of keeping inflation at 2% over the longer term.

And with investors betting on Fed rate cuts, as opposed to stronger economic growth and expanding corporate profits, a lot of stocks are going to get left behind.

That is already apparent in the weighting of the S&P 500, where just two stocks, Nvidia and Microsoft , comprise around 15% of the benchmark’s total value, the highest for any two companies on record. Their combined weight matches that of the smallest 332 stocks on the S&P 500.

Nvidia’s 13% gain last month, in fact, accounted for nearly half of the S&P 500’s 2.2% advance, according to data from the Leuthold Group.

Adding Apple, Amazon.com, Google parent Alphabet, and Facebook parent Meta Platforms takes that overall weighting to around 35%.

Those stocks, along with the biggest names in the financial sector, are likely to see the biggest gains from a Fed rate cut. And the odds of that happening next month, according to the CME Group’s FedWatch Tool, have soared to around 94%.

“Technology and other long-duration growth sectors tend to benefit most from lower yields,” said Charu Chanana, chief investment strategist at Saxo Bank. “Lower discount rates make future earnings more valuable, which helps high-growth names.”

While investors can expect more outsize gains from the megacap cohort, which in turn will drive the largest portion of the S&P 500’s advance, they should also watch the performance of the rest of the index too.

The S&P 500 Equal Weight Index , which tracks all of the benchmark’s stocks evenly, is only up 5.4% for the year, about five percentage points less than the market-cap-weighted S&P 500’s gain.

Economically sensitive sector indexes, meanwhile, are starting to lag behind.

The S&P 500 tracker of industrial stocks has gained only 0.4% over the past month, well shy of the benchmark’s 2.7% advance. Materials stocks, such as Sherwin-Williams and Newmont , have fallen 1.1% while the real estate index is down 2.6%.

Garrent Melson, portfolio strategist at Natixis IM Solutions, also notes that while “corporate earnings are beating expectations, markets are rewarding beats only modestly and punishing misses sharply.”

“That’s suggesting that much of the market’s optimism is already priced in,” he added.

Bank of America’s Fund Manager Survey would seem to support that view. A record 91% of respondents to its closely tracked August report said U.S. stocks were overvalued.

Looking ahead, tariff pressures are set to accelerate, with increased levies on a host of goods put in place earlier this month.

The economy also seems stuck in doldrums, with GDP rising at half the pace it did last year over the first six months of 2025. Goldman Sachs pegs the economy’s near-term recession odds at around 30%.

Corporate profit growth is poised to slow as well, with collective S&P 500 earnings forecast to expand by 8.3% over the current quarter and 7.1% over the final three months of the year. That compares to a 17.1% pace over the first quarter and a 13.2% advance in the second.

All that said, LPL’s Jeffery Buchbinder, the group’s chief equity strategist, isn’t ready to call time on the current bull market.

“Fiscal stimulus and transformative technology investment continue to support rich equity valuations,” he said in a recent note.

“Bouts of volatility will likely come over the next several months, but dips are likely to be bought quickly due to supportive company fundamentals, upcoming Fed rate cuts, and the power of AI that has only started to bear fruit,” he added.

Write to Martin Baccardax at martin.baccardax@barrons.com