As earnings season intensifies, bullish investors are hopeful that strong corporate results will help mitigate the recent decline in technology shares, which has cooled the U.S. stock rally this year. Over the past week, the S&P 500’s technology sector has dropped nearly 6%, shedding approximately $900 billion in market value. This decline is occurring amidst growing expectations of interest rate cuts and the possibility of a second Donald Trump presidency, which have drawn money away from this year’s winning sectors and into those that have underperformed in 2024.
The broader S&P 500 index has experienced a less severe decline, falling 1.6% over the same period. Declines in the tech sector have been partially offset by sharp gains in financials, industrials, and small caps, helping the benchmark index remain up more than 16% year-to-date.
Second-quarter earnings could play a crucial role in helping tech stocks regain their momentum. Key reports from Tesla and Alphabet are due on Tuesday, kicking off results from the “Magnificent Seven” megacap stocks, which have driven markets since early 2023. Microsoft and Apple are set to report the following week. According to Scott Wren, senior global market strategist at the Wells Fargo Investment Institute, big tech stocks have been leading the charge due to their profitability and growth in earnings.
Strong results from these leading tech companies could alleviate some of the recent concerns over stretched valuations and the massive gains seen in stocks like Nvidia, which is up 145% this year despite a recent dip. However, any signs of faltering profits or lower-than-expected AI-related spending could challenge the narrative of tech dominance that has buoyed the market this year. The performance of these megacaps is crucial, as Alphabet, Tesla, Amazon, Microsoft, Meta Platforms, Apple, and Nvidia have contributed to around 60% of the S&P 500’s gains this year.
Corporate results for these market leaders are expected to meet high expectations. The tech sector is projected to increase year-over-year earnings by 17%, and the communication services sector, which includes Alphabet and Meta, is expected to see a rise of about 22%. These gains would outpace the estimated 11% rise for the S&P 500 overall, according to LSEG IBES.
Anthony Saglimbene, chief market strategist at Ameriprise Financial, noted that many investors were surprised by a recent inflation report that solidified expectations of a September rate cut by the Federal Reserve, sparking a rotation into market areas that had struggled under tighter monetary policy. The move out of tech accelerated this week after a failed assassination attempt on Trump over the weekend appeared to boost his standing in the presidential race.
Additionally, semiconductor shares were significantly impacted by a report indicating that the United States might implement stricter export controls on advanced semiconductor technology to China. The Philadelphia SE semiconductor index has dropped about 8% since last week. Saglimbene advises investors to view pullbacks in tech stocks as an opportunity to allocate on a longer-term basis, believing that upcoming earnings reports could reduce selling pressure on Big Tech.
Despite these challenges, the broader market’s gains have given some investors confidence in the durability of this year’s stock rally. During the recent rotation, the number of advancing stocks compared to those declining over five days reached its highest rate since November, according to Ned Davis Research. Historically, when gainers outnumber decliners by at least 2.5 times, the S&P 500 has rallied an average of 4.5% over the next three months, according to NDR. “The risk is that mega-caps pull the popular averages lower, but history suggests that strong breadth improvements have been bullish for stocks moving forward,” Ned Davis strategists stated in a report.
As the earnings season unfolds, the market will closely watch the performance of the Magnificent Seven stocks. Tesla and Alphabet’s results will be particularly scrutinized for insights into their earnings growth and AI-related investments. Investors are keen to see if these companies can sustain their impressive performance and justify their high valuations. Microsoft’s and Apple’s results will follow, further testing the resilience of the tech sector.
The broader market’s reaction to these earnings reports will be pivotal in determining the direction of the S&P 500. While some sectors like financials and industrials have shown strength, the tech sector remains a critical driver of market performance. A positive earnings season could help stabilize tech stocks and renew investor confidence in their long-term growth prospects.
On the other hand, disappointing results or guidance from these tech giants could exacerbate the recent sell-off and shift investor sentiment further away from the sector. This scenario could lead to increased volatility and broader market declines, especially if investors continue to rotate into underperforming sectors in search of better opportunities.
In conclusion, the upcoming earnings season is a crucial juncture for the U.S. stock market, particularly for the technology sector. Strong corporate results from the leading tech companies could help reverse the recent decline and reaffirm their dominant position in the market. Conversely, any signs of weakness could intensify the current rotation away from tech and increase market volatility. Investors will need to navigate these developments carefully, balancing short-term risks with long-term opportunities in a rapidly evolving economic landscape.