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The artificial intelligence hype has provided a second wind for some of the megacap technology stocks – Microsoft Corp., Nvidia Corp., Meta Platforms Inc., Alphabet and Amazon.com – that have been dominating market performance for most of the past four years. But if a new research report by Scotiabank strategist Hugo Ste-Marie is accurate, the dominance will soon come to an end.

Mr. Ste-Marie pointed to an improving OECD U.S. Leading Economic Indicator index to argue that the world’s largest economy is shifting from a recovery to expansion phase. The expansion phase is typified by solid gains for equities thanks to strong earnings growth.

The expansion phase is also characterized by broad market leadership. More stocks generate strong earnings growth and the best returns come from buying earnings growth at the lowest price – the definition of a value market.

A value market would draw investor assets out of the megacap technology stocks. These stocks are secular growth stories, meaning they are less sensitive to the economy. When growth was slow during the pandemic, investors piled into technology because it was one of the few places to find decent profit growth. That’s how Microsoft, Apple, Nvidia, Alphabet and Amazon.com grew to the current 28 per cent of the entire S&P 500′s market cap.

A broadening in profit growth to sectors beyond technology would see the latter underperform. Because the S&P 500 is a cap-weighted index where returns are weighted heavily towards the largest stocks, benchmark performance could be disappointing even as the economy accelerates and earnings growth improves. This may prove a rude surprise for passive investors.

It is by no means a foregone conclusion that a U.S. expansionary phase is beginning. The Citi U.S. Economic Surprise Index, which measures important growth data relative to consensus expectations, is still in negative territory, indicated weaker than expected growth. The ISM Purchasing Managers Index for Manufacturers, a survey gauging business activity that has been historically correlated to S&P 500 earnings growth, also remains at depressed levels.

The Russell 2000 index of U.S. small cap stocks will, I think, be the tell. Outperformance by small caps is historically associated with a new market cycle and accelerating economic growth. A sustained small cap rally could very well signal the end of dominance for large cap technology stocks even if the AI hype continues.

-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

Boralex Inc. (BLX-T) This utility stock has defensive attributes, provides reliable income, and has an attractive growth profile. Over the past month, it has jumped 22 per cent, making it the second-best performing stock in the S&P/TSX composite utilities sector index. But given the swift rebound in the share price, the stock is now in overbought territory. Jennifer Dowty looks at the latest investment case.

Lloyds Banking Group (LYG-N) The Contra Guys normally focus on small or mid cap stocks. But this one is an exception. Lloyds is a huge bank with a sprawling range of businesses that is headquartered in London and has been around since 1695. It has been profitable for each of the past 10 years. Yet, there are some big challenges concerning competition and the British economy. Benj Gallander and Ben Stadelmann take a look at their investment case and why they think a double in the stock price could be in store for those who are patient.

The Rundown

Jeffrey Gundlach on recession risks, the stock market that’s a long-term buy, and how often investing pros need to be right to survive

David Rosenberg recently held a Q&A webcast with the DoubleLine CEO and billionaire investor, known as the “Bond King.” We have excerpts of some of the most valuable insight.

Others (for subscribers)

Number Cruncher: Are Canadian forestry stocks a buy yet?

Wednesday’s Insider Report: Director lands a $2.2-million payday from this large-cap stock

Wednesday’s analyst upgrades and downgrades

Tuesday’s analyst upgrades and downgrades

UBS lifts S&P 500′s year-end target to Street high of 5,600

Globe Advisor

Longevity products have role for aging Canadians, but adoption has been slow

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What’s up in the days ahead

Philip MacKellar of The Contra Guys newsletter will make the investment case for Corby Spirit and Wine, while John Heinzl provides his latest thoughts on A&W Revenue Royalties Income Fund.

Click here to see the Globe Investor earnings and economic news calendar.

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