Interest rate cuts are just one of the factors that could potentially disrupt the "summer of small-cap stocks."

The U.S. stock market under the "Great Rotation" is undergoing changes, but will this trend continue?

Or is it just a matter of time before large-cap tech stocks return to their peak?

Earlier in July, the sudden decline of mega-cap stocks like NVIDIA (NVDA) dragged down major stock indices, while small-cap stocks, defensive stocks more sensitive to interest rate changes, and value stocks such as financials rebounded.

Value-oriented indices such as the Russell 2000 small-cap index, the S&P MidCap 400 index, and the Dow Jones Industrial Average outperformed the S&P 500 and the Nasdaq Composite, and recorded the largest outperformance margin in years, indicating the initial signs of the "Great Rotation."

In the "summer of small-cap stocks," small-cap stocks continue to outperform, and to some extent, the "Great Rotation" is still ongoing.

Dow Jones Market Data shows that in the 10 trading days ending July 23, the Russell 2000 outperformed the S&P 500 by 10.8 percentage points, the largest outperformance margin on record.

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Last week, the S&P 500 fell by 0.8%, the Nasdaq fell by 2.1%, the Dow rose by 0.75%, and the S&P SmallCap 600 index rose by 3.6%.

The U.S. stock market's "Great Rotation" beneficiaries' ability to hold onto recent gains or rise further depends on the following three factors.

The reason for the Federal Reserve's interest rate cuts: Before the arrival of this summer, the stocks leading the market seemed to be on the verge of a change: large-cap tech stocks and other mega-cap stocks had become very expensive, while small-cap, mid-cap, and value stocks were very cheap.

However, Mike Reynolds, Vice President of Investment Strategy at Glenmede, pointed out that a catalyst was needed for the "Great Rotation" at that time.

After the U.S. CPI data for June was released on July 11, investors raised their expectations for the number of times the Federal Reserve would cut interest rates in the coming year.

According to data from the CME Group, traders now believe that there is a high probability that the Federal Reserve will cut interest rates six times before August 2025.

The expectation of interest rate cuts has risen sharply in the past month.

Investors believe that the Federal Reserve will cut interest rates six times from now until July 2025.

Whether the Federal Reserve will really cut interest rates so many times may have a profound impact on small-cap stocks before the end of the year.

However, it's not just the number of interest rate cuts that's important, but also the reason for the cuts.

Reynolds said, "The reason for the Federal Reserve's interest rate cuts is important.

If it's because they see economic weakness and believe it's necessary to start implementing loose monetary policy, then the benefits of interest rate cuts are not as great for small-cap stocks, which are more sensitive to economic conditions."

Profits: Recently, the market's expectations for small-cap stock earnings growth have been warming, at least for higher-quality components in the S&P SmallCap 600 index.

Data from Bank of America Global Research shows that the earnings growth rate of the components of the S&P SmallCap 600 index will exceed that of large-cap stocks starting from later this year, and this trend will continue until 2025.

If this optimism fades, small-cap stocks may not be able to maintain their current upward momentum.

John Lynch, Chief Investment Officer of Comerica Wealth Management, said, "Cyclical stocks, value stocks, and small-cap stocks must prove that their earnings growth is indeed expanding, otherwise what we are seeing will just be a 'late cycle' rally, and nothing else."

However, during the period from now until the aforementioned stocks prove that their earnings growth is indeed expanding, the rotation trade could potentially "derail."

If the earnings reports of a few other companies among the tech "seven giants" can impress investors, it might attract investors to flood back into mega-cap stocks.

On the other hand, if their earnings reports fail to meet investors' high expectations, the selling of mega-cap stocks could become even more severe.

Jason Draho, Head of Asset Allocation for the Americas at UBS Global Wealth Management, said, "Can tech stock earnings reports be enough to revive investor confidence?

Investors will be watching their earnings reports and how they perform compared to expectations."

So far, investors have been voting with their feet.

After Alphabet (GOOGL) and Tesla (TSLA) released their earnings reports, their stock prices plummeted, and other mega-cap tech stocks were also dragged down.

"Trump Trade": Many stocks that have benefited from the "Great Rotation" have also been caught up in the "Trump Trade."

Strategists have pointed out that if Trump were to return to the White House, government policies might be more favorable to smaller market cap companies that focus more on the domestic U.S. market.

Lynch of Bank of America Global Research believes that at the same time, Trump's aggressive rhetoric towards Taiwan and large tech companies, coupled with his trade protectionist agenda, could further damage many stocks that have benefited from the boom in artificial intelligence.

Reynolds said that the policy positions of the Democratic presidential candidates are still unknown, adding another layer of uncertainty.

It may ultimately come down to the control of the House and Senate.

Alex McGrath, Chief Investment Officer of NorthEnd Private Wealth, pointed out that a "divided government" would tend to maintain the status quo.

McGrath said, "We believe that the control of the House and Senate is the biggest unknown factor."