A healthy correction underway

Markets feel more fragile than headline indices suggest, as sharp pullbacks in Bitcoin, software and mega-cap AI leaders contrast with steady gains in small caps and the “unloved” majority of the S&P 500. Federated Hermes views the current tech correction as healthy but unfinished, with hyperscalers’ rising capex eroding their asset‑light appeal and software names facing both post-pandemic demand digestion and disruptive AI threats to traditional licensing models.

At the same time, improving economic data, better‑than‑expected earnings and rising forward estimates are underpinning a rotation into smaller-cap and value stocks, where fundamentals are strengthening while valuations remain attractive. This broadening leadership is supported by an emerging “Goldilocks” backdrop of easing policy alongside accelerating earnings, historically favorable for small caps, cyclicals and value-oriented sectors.

The main risk to this constructive view is a potential credit event tied to stressed parts of tech and crypto markets, which remains contained for now but warrants close monitoring.