Small Caps Lead, Mag 7 Lags, Yields Steer

Every morning before the opening bell, the Schwab Market Update sets the stage for the day ahead, covering key market movers, economic developments, and emerging themes. Each edition includes "Three things to watch," and Thursdays feature a weekly section, "Crypto currents." This recap revisits select items for those who may have missed them, helping traders head into the weekend better informed.

The second quarter of 2026 was arguably a tale of two quarters, with a firm line between June and the first two months of the quarter. The potential winding down of the Iran war last month appeared to be one factor clipping the technology rally, with falling oil prices helping relieve pressure on more cyclical sectors like industrials and financials on hopes for improved economic growth. Before that, higher crude and yields kept most sectors in check, with investors congregating in the tech sector where such metrics tend to have less immediate impact. Tech got challenged by many other factors in June, including highly publicized flows of talented personnel from the Magnificent Seven into the chip stocks, worries about margin for big data center providers as memory chip prices climbed, and concerns that the tech sector had too much leverage in the stock market that might make it vulnerable to selling. Barring a return to full-scale hostilities in the Middle East, earnings season is likely the next major catalyst.

Can the Magnificent Seven and semiconductor stocks both rally into year-end? "It's possible, but I believe that would require firm evidence of AI monetization, or a healthy ROI from the hyperscalers when they report later this month," said my colleague Nathan Peterson, director of derivatives research and strategy at the Schwab Center for Financial Research, or SCFR. Investors may be growing less tolerant of the heavy spending by the hyperscalers, and have shifted toward the beneficiaries of that spending, as evidenced by the 80% gain in chip stocks and negative returns for the Mag 7 so far this year. Chip companies have delivered strong results to back those gains, while questions over the long-term ROI on heavy hyperscaler spending have moved some investors to the sidelines. Another concern is that the AI infrastructure spending is driven by expectations of strong end-user demand for AI offerings, while recent news reports indicate a price war is brewing. Does that imply a downward revision to future revenue streams, and would that put capital spending budgets under review? We'll know more about budgets when the Mag 7 report later this month, but it seems a reset in investor expectations around the AI trade is a distinct possibility, Peterson said.

The Russell 2000^® (RUT) gained 22% during the first half of the year, its best since 1991 and well above the S&P 500's 9.6% gain. In fact, the RUT topped the S&P for two consecutive quarters, the first time that's happened since 2021. What's driving this performance by small caps? Clearly, it represents a broadening of market participation, and generally signals growing confidence in the economy, as smaller companies' earnings are more sensitive to economic conditions. As some of the mega-cap tech names have faltered, particularly in the second quarter, small caps have seen inflows in some of the same speculative sectors, such as AI and quantum computing. But that's not all. Energy, biotech, and health care have also caught bids, and small-cap value stocks have kept pace with their growth counterparts. All of which is healthy for stocks generally. But how long can the move last? The only thing we can say for sure is that past performance is no guarantee of future results.

Net outflows of funds from spot bitcoin exchange-traded products (ETP) are regaining speed, with the seven-day average hitting the highest level in about a month on Monday. The total since May 1: $8.74 billion. But there are hopeful signs for bulls as bitcoin sits just above its bear market low. Both long-term holders, with positions at least 155 days old, and so-called whales, with at least 1,000 bitcoins, have been buying steadily in recent weeks, though in modest volumes, according to Glassnode data. Their analysts call that "an encouraging sign that conviction is beginning to rebuild beneath the surface." An even more constructive sign is that smaller position holders (those with less than one bitcoin) and those with 100 to 1,000 bitcoins are showing the strongest accumulation patterns, they said, noting that confirmation will require sustained buying.

Last week's rotation out of tech and into sectors like industrials and health care could get a second wind in coming days, but it depends partly on the path of Treasury yields. Which means it could partially depend on crude oil, though yields have seemed less correlated with crude of late even as oil prices have dipped to nearly pre-war levels. If oil rises, however, the 10-year Treasury note yield could, too, possibly hurting chances for a non-tech rally. When the yield has been below 4.5% lately, money has gone into sectors beyond tech. When yields climb to 4.5% or higher, money gravitates back toward tech. Jobs data could have an impact on yields, which are down over the last week despite growing expectations of a possible Federal Reserve rate hike sometime this year.