The Nasdaq and the S&P 500 fell from record highs Thursday, weighed by megacap stocks, as investors favored small-caps after a softer-than-expected inflation reading bolstered hopes that the U.S. central bank would cut interest rates in September.

A Labor Department report showed U.S. consumer prices fell unexpectedly and the annual increase was the smallest in a year, reinforcing the view that the disinflation trend was back in play.

The data is a welcome sign for Federal Reserve policymakers seeking evidence that inflation is back on track to their 2% goal, leading traders to increase bets on a September rate cut.

Despite the positive news on the inflation front, megacap stocks slumped, with Apple, Microsoft, Alphabet and Nvidia down between 2.6% and 4.9%.

However, the Russell 2000, which has significantly lagged the benchmark index this year, jumped 3.1% to an over three-month high, on expectations that interest-rate cuts would improve conditions for smaller companies.

Wall Street's rally this year has primarily been driven by its largest stocks, with other sections of the market underperforming, leading some to question whether such narrow gains could be sustained.

"We've said for some time that the concentration (in tech) was getting really extreme. If the Fed is now shifting tack from tightening to loosening, eventually that should mean brighter economic days ahead and a rotation away from this narrow group of companies to a wider berth of opportunities," said Sameer Samana, senior global markets strategist at Wells Fargo Investment Institute.

The S&P 500 Real Estate Index jumped 2.7%, topping sectoral gainers and trimming its year-to-date losses to under 1%. Communication Services and Information Technology lost over 2.4% each.

The S&P 500 and the Nasdaq scaled fresh record highs in range-bound trading when markets opened.

Among headlining stocks, Delta Air Lines slumped 5.3%, on track for its biggest one-day fall since mid-January, after forecasting lower-than-expected profits in the current quarter.

Other major airline stocks also tumbled, with an index of S&P 500 passenger airline companies falling 4.1%.

"This might be a place where consumers are getting pinched by inflation. That's showing up in discretionary funding on things like air tickets," said Scott Helfstein, head of investment strategy at Global X.

Investors will now look ahead to the Producer Price Index reading for insights into the inflation trajectory, along with second-quarter earnings from big banks, both due on Friday.

At 12:12 p.m. ET, the Dow Jones Industrial Average was up 58.88 points, or 0.15%, at 39,780.24, the S&P 500 was down 41.57 points, or 0.74%, at 5,592.34, and the Nasdaq Composite was down 293.95 points, or 1.58%, at 18,353.50.

Tesla slumped over 6% after a report the EV maker was delaying the launch of its Robotaxi, while Citigroup slipped 1.6% after U.S. bank regulators fined the lender $136 million.

Conagra Brands fell 2.6% after the packaged foods maker forecast annual revenue and profit below estimates.

Advancing issues outnumbered decliners by a 5.30-to-1 ratio on the NYSE, and by a 3.00-to-1 ratio on the Nasdaq.

The S&P 500 index recorded 47 new 52-week highs and one new low, while the Nasdaq recorded 126 new highs and 34 new lows.