As earnings season gains momentum, optimistic investors are banking on robust corporate results to counter the recent decline in technology shares, which has cooled this year’s U.S. stock rally. The S&P 500’s technology sector has experienced a nearly 6% drop in just over a week, resulting in a market value loss of approximately $900 billion. This decline is driven by expectations of interest rate cuts and the possibility of a second Donald Trump presidency, diverting funds away from tech winners and toward sectors that have lagged in 2024.
However, the broader S&P 500 index has weathered the storm better, with a 1.6% decline over the same period. This decline in tech has been partially offset by strong gains in other areas such as financials, industrials, and small caps. Overall, the benchmark index remains up more than 16% year-to-date.
The upcoming second-quarter earnings reports could be a turning point for the tech sector. Tesla and Google-parent Alphabet are set to kick off results from the “Magnificent Seven” megacap stocks that have driven markets since early 2023. Microsoft and Apple will follow suit in the subsequent week.
Scott Wren, senior global market strategist at the Wells Fargo Investment Institute, emphasizes that big tech stocks have been leading the charge due to their solid financial performance and growth in earnings. These results could alleviate concerns about stretched valuations and the recent volatility in stocks like Nvidia, which has seen eye-watering gains despite a recent dip.
However, there’s a caveat. If profits disappoint or artificial intelligence-related spending falls short of expectations, it could challenge the narrative of tech dominance that has fueled stock gains this year. Notably, Alphabet, Tesla, Amazon.com, Microsoft, Meta Platforms, Apple, and Nvidia account for around 60% of the S&P 500’s overall gain.
Analysts project a strong showing for the tech sector, with year-over-year earnings expected to increase by 17%. Additionally, the communication services sector, which includes Alphabet and Facebook parent Meta, is anticipated to see a 22% rise in earnings. These gains would outpace the estimated 11% increase for the entire S&P 500, according to LSEG IBES.
Anthony Saglimbene, chief market strategist at Ameriprise Financial, suggests that investors were caught off guard by an inflation report, leading to expectations of a September rate cut by the Fed. This sparked a rotation into other market areas that have struggled under tighter monetary policy.
The recent shift away from tech accelerated after a failed assassination attempt on Trump over the weekend, which seemed to boost his standing in the presidential race. Additionally, semiconductor shares took a hit following reports of potential tighter restrictions on exports of advanced semiconductor technology to China.
Despite these challenges, Saglimbene advises investors to view pullbacks in tech as long-term allocation opportunities.
The recent broadening of gains across different market segments has encouraged investors regarding the resilience of this year’s stock rally. During the recent rotation, the number of stocks experiencing gains over five days has reached its highest rate since November, as reported by Ned Davis Research.
Historically, when gainers significantly outnumber decliners (by at least 2.5 times), the S&P 500 tends to rally an average of 4.5% over the subsequent three months. This trend suggests that strong breadth improvements—where many stocks participate in the upward movement—have been favourable for stocks moving forward.
While there is a risk that mega-cap stocks could exert downward pressure on popular market averages, historical patterns indicate that robust breadth improvements bode well for the overall market.