As the calendar flips to July, a dramatic shift is taking place beneath the surface of the stock market. While the S&P 500 saw only a modest dip of around 0.3%, the underlying rotations across sectors and strategies reveal a deeper story—one driven by a rapid unwinding of momentum trades and a resurgence in previously lagging areas of the market.

The Momentum Trade Hits a Wall

A sharp reversal in high-flying momentum stocks sent shockwaves through portfolios. A diversified basket of momentum-driven names registered its steepest single-day loss since January, plunging over 5%. The selloff wasn’t one-sided—the long positions, which typically include strong year-to-date winners such as tech and AI-related names, dropped nearly 4%. On the other side of the trade, short positions, which usually target underperforming or out-of-favor stocks, surged nearly 2%, suggesting a broad-based squeeze on bearish bets.

The abrupt nature of this move points to a technical shakeout more than a headline-driven event. With no clear macroeconomic catalyst, traders and investors appear to be locking in gains ahead of two key events: the upcoming nonfarm payrolls report and the long Independence Day weekend in the U.S. The combination of reduced liquidity and risk reduction strategies has accelerated this internal market rotation.

AI Stocks Retreat, Cyclicals Rebound

Once a hotbed of speculative enthusiasm, artificial intelligence-focused equities took a notable hit, falling around 3%. This drop hints at a broader cooling-off period for one of 2024’s most crowded trades. Meanwhile, stocks that had been left behind are now roaring back to life.

Sectors like housing and so-called “tariff losers”—companies previously hurt by trade tensions and global supply chain dynamics—posted strong gains, rising over 4% and 2% respectively. This reversion suggests that investors are now scouring the market for relative value, shifting from high-momentum winners to fundamentally discounted or policy-sensitive names.

Seasonal Strength Meets Tactical Uncertainty

Historically, July has been a strong month for U.S. equities. The S&P 500 tends to advance by approximately 1.3% on average, with much of those gains typically front-loaded in the first half of the month. This seasonal tailwind could partially explain the recent positioning, as investors may have already attempted to price in July’s expected strength.

Yet, the latest market action poses an important question: Have these seasonal gains been “front-run” too aggressively this year? If so, the latter half of the month may prove less fruitful for bullish traders unless new catalysts emerge.

Financials Enter the Spotlight

One sector bucking the trend with renewed vigor is U.S. financials. Historically, July has been a standout month for the group, particularly for large-cap banks. These institutions are now back in favor, benefiting from a combination of solid earnings expectations, attractive valuations, and growing optimism around deal-making and capital markets activity.

Beyond the big names, smaller and more specialized corners of the financial world are drawing attention as well. Regional banks, which have lagged amid interest rate concerns and regulatory scrutiny, are showing signs of life. Similarly, banks leveraged to mergers and acquisitions, along with alternative asset managers, are being eyed for potential catch-up rallies.

The swift unwind in momentum and the rotation into laggards underscores a key theme for July: flexibility and selectivity. Investors who have benefited from high-momentum trades in AI and tech should consider taking profits or tightening risk controls, especially in the face of seasonal and macroeconomic uncertainty.

On the flip side, areas of the market that have been overlooked—such as regional banks, housing stocks, and cyclicals—could offer asymmetric upside as capital reallocates into undervalued or structurally improving names.

While the overall index movements may appear tame, the internal dynamics of the market are shifting rapidly. For active investors, staying attuned to these rotations will be critical in navigating the summer months ahead.