The gangbuster stock market rally led by Big Tech and AI has cooled. Plus, the Federal Reserve may finally be closer to its first interest rate cut. So, if you have $10,000 to invest now, what should you buy?
The set up isn't great with uncertainty and market volatility on the rise. The large-cap S&P 500 is pulling back from record highs. Tech stocks, including AI chip leader Nvidia, are giving back chunks of their gains. And stock valuations are on the fuller side.
As a result, money managers aren't pounding the table to buy stocks — at least not the recent winners, such as the Magnificent Seven tech giants that have been responsible for the bulk of the market's returns.
"Everything's a little pricey right now, and we haven't really had the summer pullback that we usually have," said Lamar Villere, portfolio manager at money management firm Villere & Co. Staying in cash for now, he adds, isn't a bad thing for those who expect a market correction. Some money market funds currently yield 5% or more, according to Bankrate.com.
Getting More Cautious With The Stock Market
Instead, the money managers and market strategists IBD talked are getting more cautious. Instead of doubling down on market leaders, they're touting parts of the stock market that have been forgotten, such as small-caps and value stocks.
Investment pros also recommend people move money out of cash and into short-term bonds to lock in higher rates for longer. They're also touting broad diversification to take advantage of a possible market rotation away from Big Tech and a broadening out of the market toward smaller-cap names and value stocks.
Small-Cap Stocks
No doubt, the biggest stocks on the planet and ones with an early lead in AI have been market superstars. But a big opportunity exists now to buy small stocks. "Right now, they're historically cheap," said Ryan Detrick, chief market strategist at Carson Group.
How cheap? "The last time small caps were this cheap relative to large caps was 1999 (during the dot-com bubble), which kicked off a 13-year period of outperformance," said Detrick.
The buy-small-caps-now call is not just about valuation, though. Historically, small stocks tend to rely on borrowed money for growth. They like rate cuts. And with inflation trending lower and the market expecting the first Fed rate hike in September and three quarter-point cuts by year-end, small caps win.
"Lower rates, even slightly lower, could be a big tailwind for small cap stocks," said Detrick.
If rates fall, small caps earnings could outpace large stocks for the remainder of the year, says Ryan Rosegarten, senior wealth strategy associate at UBS Global Wealth Management.
Total U.S. Stock Market Index Funds
If the Magnificent Seven lose their dominance, the so-called "other 493" stocks in the S&P 500 could see a resurgence. With uncertainty rising as to where returns might come from, the case for diversification rather than concentrating on a few winners grows louder.
"Being broadly diversified is really important," said Chris Tidmore, senior manager in Vanguard's Investment Advisory Research Center. "(Investors) are always looking for the needle in the haystack. But the way to make sure you own the needle is to own the whole haystack."
Toward that end, investing in a total U.S. stock market fund means you own virtually every domestic publicly traded stock. "Pick a name," said Tidmore. He adds that the best stock to own is the small cap that grows up to be a large-cap juggernaut.
And if you're deciding whether to put the $10,000 to work all at once or dollar-cost average the money in over time, Tidmore recommends going the lump sum route. "All the academic research says put all the money to work right away," said Tidmore.
Pick-And-Shovel Plays
Sure, AI chipmakers are hot stocks, but you don't necessarily need to own companies like Nvidia that make semiconductors. Instead, you can play the AI and digitization play by buying shares of the manufacturing companies that make the equipment needed to build high-powered computer chips, says Erin Kolo, manager of PWM equity and fixed income research.
Chip equipment makers are under pressure in recent weeks amid signals the U.S. will restrict the sales of chips to China. Still, given the ongoing demand for chips needed to build-out AI, these stocks will continue to be a sound investment over a longer-term time horizon, says Kolo.
"The demand for chips, obviously, will continue to rise," said Kolo.
Top-10 holdings in iShares Semiconductor ETF include chip equipment plays, including Applied Materials, Taiwan Semiconductor, and KLA, according to fund tracker Morningstar. VanEck Semiconductor ETF owns sizable positions in Netherlands-based ASML Holdings and Lam Research.
Short-Term Bonds Vs. The Stock Market
Money markets are yielding 5% now. But those rates will reset lower quickly once the Fed starts to cut rates as inflation subsides, taking a sizable haircut out of savers' income. That's why Daniel Siluk, manager of Short Duration Income ETF at Janus Henderson Investors, believes there is an argument to reallocate away from money markets and into shorter-dated bonds.
By being "lazily parked in cash," investors may be unable to participate in any potential capital appreciation in bond markets brought about by falling rates, says Siluk.
Siluk says short-term Treasuries and investment-grade credit are a "pretty attractive place to be." By investing in bonds with maturities of one to five years, you not only can capture extra yield, but can also get capital appreciation as the Fed cuts rates. This trade, however, doesn't mean the investor will give up liquidity or quality. "These are deeply liquid asset classes," said Siluk.
Siluk says the time for investors to make the move is now, before the Fed begins its rate-cut cycle.
So, for investors who are not certain whether now is the time to buy stocks, buying one- or two-year Treasuries allows them to lock in an attractive yield while they wait to deploy the cash into so-called risk assets, says Justin Winters, managing director and partner at financial advisory firm Treasury Partners.
"It gives you the most flexibility," said Winters. "You lock in that rate for longer. Not only is your money protected, but if the markets pull back, you can take advantage of that and rotate back into equities at lower levels."
Value In The Stock Market
It's been a growth market for a while, but value offers value. Fed rate cuts will benefit value stocks, which perform better when the economy picks up, says Rosegarten of UBS. "We envision stocks whose performance is tied to the direction of the economy and that are hypersensitive to interest rates will benefit as we approach a lower rate regime," said Rosegarten.
Foreign Stocks
Investors often have a U.S.-centric view of their investments. But there's opportunity outside U.S. shores. With rates finally coming down and dollar strength expected to moderate, the outlook for emerging markets is brightening.
"Investing in emerging markets (ex China) is one of the most interesting opportunities right now for longer-term investors," said Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions. His firm expects annual returns of 9.6% in emerging markets for the next 10 years. "We think many emerging markets countries and stocks will provide solid relative returns given higher economic growth rates, better population demographics and improving corporate management and governance."
Angus Shillington, deputy portfolio manager for the emerging markets equity strategy at VanEck, is bullish on India stocks. Over the long term, the Indian stock market, he says, delivers 7% growth on top of the country's GDP, second best behind the U.S. on that metric, he says. Currently, transformational change is occurring in India, says Shillington.
So what are you waiting for? Put that $10,000 to work.
