ORLANDO, Florida, Aug 28 (Reuters) - Amid the Federal

Reserve drama and deluge of corporate earnings in August, one

clear but overlooked trend emerged in U.S. equities: the

rotation out of expensive tech stocks and into cheaper small

caps. As the month draws to a close, the big question is whether

this can continue.

The Nasdaq 100 is currently on track for a monthly gain of

1.5% while the Russell 2000 small cap index is headed for a 7.3%

rise, signaling an underperformance of 580 basis points for the

tech-heavy index.

According to Stuart Kaiser, head of equity trading strategy

at Citi, that relative monthly performance for the Nasdaq 100 is

in the bottom 5% since 1985.

And if we look at ETFs, tech's underperformance looks even

more striking. This month, the Invesco QQQ exchange-traded fund

tracking the Nasdaq 100 is flat, while the iShares Russell 2000

ETF is up 7%.

FED BOOST

So what's responsible for this dramatic divergence?

It may partly just reflect investors seeking to rebalance

their concentrated and lopsided portfolios. But the split was

clearly turbo-charged by Federal Reserve Chair Jerome Powell's

Jackson Hole speech on August 22, when he opened the door to an

interest rate cut next month.

Manish Kabra, head of U.S. equity strategy at Societe

Generale, says the Russell 2000 index's outperformance against

the broader S&P 500 that day was the biggest since the U.S.

election on November 6 last year that returned Donald Trump to

the White House.

Powell's dovish pivot is helping small caps outperform

because these companies tend to benefit more from lower interest

rates given that they rely on borrowing to grow and expand.

Larger firms, especially 'Big Tech' megacaps, often have huge

cash reserves and easier access to other sources of financing.

To be sure, lower rates wouldn't just be good news for small

caps. The rising tide of liquidity and investor sentiment would

typically be expected to lift all boats, including the

'Magnificent Seven' megaships.

As analysts at UBS point out, past equity bubbles have often

been burst by rising interest rates, so a resumption of the

central bank's easing cycle would appear to minimize that

particular risk for high-priced tech stocks.

But, regardless, small caps may still continue to get more

of a Fed boost in the near term.

AI DOUBTS

Another catalyst for the rotation has been creeping doubts

about AI's ability to deliver returns commensurate with the

bubble-like frenzy surrounding the new technology.

Tech stocks remain on the pricey side. That's justified,

argue UBS analysts, by the potential revenue from AI-generated

efficiencies, which they estimate could reach around $1.5

trillion a year globally.

Others are less optimistic. If value creation on this

massive scale fails to materialize, then tech companies will

struggle to generate a return on the trillions of dollars of

global capex expected in the coming years.

That's why all eyes were on $4.4 trillion Nvidia's earnings

on Wednesday. How investors interpret the global AI leader's

results will help determine whether tech's underperformance

continues into September. The company's revenue, profit and

forecasts looked solid, but uncertainty surrounding the

suspension of its business with China and skepticism around the

revenue outlook are giving investors pause.

UNDER THE RADAR

For now, market momentum remains with smaller firms. Francis

Gannon, co-CIO and managing director at Royce Investment

Partners, calls it a "stealth summer" for small caps, the recent

outperformance of which has gone "mostly unnoticed" amid the

daily headlines centered on economic uncertainty, geopolitical

worries, and new highs in the larger cap-led indices.

Indeed, the Russell 2000 has yet to revisit last November's

peak, while the Nasdaq and S&P 500 have been printing new highs

for weeks.

Whether or not small caps start hitting new records will

likely be determined by what happens at the Fed.

So the big macroeconomic events to watch next month will be

the August employment report due on September 5, August CPI

inflation data on September 11, and then, of course, the Fed's

policy decision on September 17.

Small caps have enjoyed a pleasant end to the summer. Let's

see what happens when investors all get back to their desks next

month.

(The opinions expressed here are those of the author, a

columnist for Reuters)