The momentum trade that propelled the US stock market through the first half of 2026 is showing signs of weakening, according to Bloomberg US Equities Reporter Natalia Kniazhevich. This shift comes after a softer-than-expected June payrolls report, which saw nonfarm payrolls at 57,000, well below estimates ranging from 100,000 to 110,000. While the unemployment rate slightly dropped to 4.2%, and average hourly earnings firmed to $37.64 (up from $36.36 a year prior), the report led to a rapid repricing of the Federal Reserve's outlook, with July rate-hike odds effectively at zero and only about 30 basis points of Fed moves expected by year-end. The Fed funds target upper bound remains at 3.75%, unchanged since December 10, 2025. This has prompted institutional investors to rotate into cyclicals, small caps, and European equities, while retail traders continue to favor AI leaders.
Evidence of this rotation is seen in the performance of key ETFs: The Invesco QQQ Trust (NASDAQ: QQQ), representing tech-heavy momentum stocks, is up 16% year-to-date but has slipped 4.5% over the past month. In contrast, small caps, as measured by the iShares Russell 2000 ETF (NYSEARCA: IWM), are outperforming, up 20.89% year-to-date and 2.03% higher over the last month. UK equities, via the iShares MSCI United Kingdom ETF (NYSEARCA: EWU), are up 8.78% year-to-date and gained 2.79% in the past week. This indicates a divergence in market leadership.
Despite institutional selling of momentum stocks, retail investors remain heavily invested in AI, hyperscaler, and megacap tech names, with cash equity trading volume roughly 65% higher than in 2025. This creates a tug-of-war in the market heading into the summer. The volatility index (VIX) spiked to 22.22 on June 10 before easing to 16.59 on July 1, suggesting a positioning cleanup rather than a broader risk-off event. Analysts recommend investors focus on which parts of the market are positioned to lead the next leg higher, with some suggesting leadership will broaden if wage growth continues and the Fed maintains rates at 3.75%.
