In the upcoming earnings season, the record-breaking US stock rally faces a critical test as corporate earnings reports begin. The S&P 500’s ascent, driven by tech giants and AI, hinges on impressive results amid high expectations. Analysts anticipate strong profit growth, especially from mega-cap tech, yet challenges loom amid broader market dynamics and global economic uncertainties.
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By Esha Dey and Jessica Menton*
A non-stop rally in US stocks since April is facing a major test as companies start reporting earnings next week.
The S&P 500 Index has notched one record after another, powered by the so-called Magnificent 7 and all things artificial intelligence. Companies will have to impress as expectations are elevated, especially for mega-cap technology stocks. Though still robust, big tech earnings are projected to slow.
Analysts estimate that members of the benchmark will see second-quarter profits rise 9.3% over the prior-year period, which will be the biggest such expansion since the last three months of 2021, data compiled by Bloomberg Intelligence show.
The S&P 500 rose 3.9% in the last quarter, and has since advanced another 2.8% through Friday’s close.
“The hurdle is high,” Ed Clissold, chief US strategist at Ned Davis Research wrote in a note to clients this week. “Even strong beats may not be enough for the Magnificent 7 growth rate to continue to accelerate.”
Investors will look for clues on the health of the consumer, especially after PepsiCo Inc.’s sales disappointed this week and Delta Air Lines Inc. said domestic carriers were struggling to fill planes even in the all-important summer travel season.
Earnings season kicked off on Friday, with banking bigwigs JPMorgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. reporting generally mixed results. Other companies including BlackRock Inc. — the world’s largest asset manager — and Netflix Inc., along with JB Hunt Transport Services Inc. will deliver results next week.
Here’s a look at five key themes to watch:
Broader Rally
For the first time since 2022, investors will likely shift their attention to the rest of the 493 companies in the S&P 500. Companies outside of tech are expected to report their first quarterly earnings growth in at least six quarters. Profits are estimated to grow 5.4% and are seen accelerating toward double-digit increases by the final three months of the year, according to data compiled by BI.
“Growth is broadening out and so should the market,” Bank of America’s equity and quant strategists Ohsung Kwon and Savita Subramanian said in a note this week.
The Magnificent 7 — Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc., Nvidia Corp., Meta Platforms Inc. and Tesla Inc. — is on course for a slowdown in growth. Profits are expected to rise by 29%, compared to average earnings growth of 35% in 2023, when the rest of the S&P 500 fell 5%, according to BI.
Mixed Industry Outlooks
Traders are betting that share prices will not move in unison this earnings season making it difficult to pick winners. While inflation is ebbing, differing outlooks for S&P 500 industries has left a gauge of expected one-month correlation in the index’s stocks hovering at its lowest in more than a decade, data compiled by Bloomberg show. A reading of 1 means securities will move in lockstep, it’s currently at 0.03.
This comes as three of the 11 groups — tech, communication services and health care — are set to post profit expansions of more than 10%, while real estate, industrials and materials companies will likely see profits shrink. Low correlations are welcomed by fund managers looking to beat indexes through stock picking.
At the same time, options are implying an average move of 4.3% in either direction on earnings for S&P 500 members, which is above the historical average of 4.1% since 2012, said Vishal Vivek, equity trading strategist at Citigroup.
“Investors chasing alpha should focus on earnings-related moves,” Vivek said in a phone interview, especially as earnings-day volatility relative to non-earnings days has increased to its highest level since 2018.
China Recovery
A long-awaited earnings recovery in China has so far failed to come to fruition and results aren’t expected to improve much in the second half of 2024. Hurting growth prospects are a slew of deep-rooted issues — from a housing sector downturn to demographic headwinds — that are hard to resolve.
Home appliance and new electric vehicle makers are among those well-placed to benefit from the nation’s export boom. Still, earnings trajectory of these industries face risk of derailing as Western governments set up trade barriers. The economic impact of such tariffs or restrictions have been limited so far but may eventually erode profits at corporations.
US companies and investors watch for signs of any weakness in China’s economy that can ripple through the global economy, namely consumer discretionary, technology, industrials and autos.
Read more: ‘China is very much on our radar,’ US economy shows unexpected resilience – Mark Perchtold (OMBA)
AI Trade
Artificial intelligence will continue to be in the spotlight. As the mega-caps’ pace of earnings expansion is set to decelerate, close focus will be on how companies such as utilities and data centers are deploying capital into AI and whether those investments will boost stock valuations.
“The AI trade is under increasing scrutiny,” Goldman Sachs strategists Ryan Hammond and David Kostin said in a note this week.
“Investors are increasingly concerned about the potential returns to the hyperscalers’ AI investment spending,” they said, referring to Amazon.com, Meta, Microsoft, Alphabet. Analyst sales estimates for the companies have not increased commensurate with investment spending, they added.
The strategists recommend looking at “sales revisions as a key indicator for the durability of the AI trade.”
Election Year Risks
The one wild card for equities this year is the US presidential election and the policy-related uncertainties that come with it. Companies that make electric vehicles, EV batteries, semiconductors, solar cells, critical minerals, steel, aluminum face risks, and regulation-heavy groups like financials and health care will be in the cross hairs. Investors will be parsing earnings calls for comments and outlooks that will hint at potential risks to companies’ bottom lines.
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