Small caps have nearly caught up to the S&P 500: Morning Brief

This is The Takeaway from today's Morning Brief, which you can sign up to receive in your inbox every morning along with:

Tech stocks led the S&P 500 ( ^GSPC ) lower Tuesday as the Nasdaq 100 ( ^NDX ) closed at the lowest level since early June.

It was the fourth day the tech-heavy index lost 1.5% or more in the month of July, especially notable as there had not been any losses of that magnitude in the two prior months.

Ahead of June's Consumer Price Index reading on July 11, the Nasdaq 100 had been up 23% year to date. But after the CPI registered its first monthly drop in inflation since 2020 , investors kicked off a stomach-churning rotation from large stocks into small.

Since then, the Nasdaq has surrendered half those gains, sending many investors into relative shock upon learning that the laggard Russell 2000 index ( ^RUT ) has nearly caught up to the volatile index known as home to the largest tech players.

"[I] didn’t have [the] Russell 2000 catching the Nasdaq 100 year-to-date on my bingo card to start this month. Getting close," wrote Jay Woods, chief global strategist at Freedom Capital Markets and former NYSE floor governor.

The Russell 2000 is now sporting a better return this year than the artificial intelligence-fueled S&P Select Tech SPDR Fund ( XLK ) — and it's only a few points away from catching the S&P 500.

In the month of June alone, the Nasdaq outperformed the Russell 2000 by over 7 percentage points. Then, in July, the relationship violently inverted such that the Russell outperformed the Nasdaq by nearly 14 percentage points. It's the biggest month-to-month flip in leadership that we have data for, going back to 1988.

The narrative in the press followed the rotation as grave concerns over market concentration in the Magnificent Seven gave way to a small-cap miracle rally.

To be clear, sector rotation is a healthy feature of bull markets. When a leading group of stocks takes a back seat, other pockets of the market should take their place such that — at the index level — volatility is subdued. Extremes on either side average out.

But, given the speed and strength of the recent move, Wall Street is now assessing the damage to institutional portfolios.

According to Morgan Stanley's derivatives team , "volatility of the last two weeks started out being very rotational."

However, as the move gained steam, institutions began reining in leverage (borrowed money) and reducing directional bets on stocks. "What began as a de-grossing event has quickly turned more towards a shift in directional exposure to equities," the team continued.

All of this, and there's still a Fed meeting later today and a Meta quarterly report to close July. Buckle up.