(Bloomberg) — The seemingly unstoppable US stock market continues to rise despite Big Tech’s slump, as the gains diversify to industry groups like real estate that struggled through the first half of the year.
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The same, however, cannot be said for corporate profits. And that raises a question about how long the breadth of the rally can stay strong.
“The rally might be broadening out in terms of the action in the stocks,” said Matt Maley, chief market strategist at Miller Tabak + Co. “But it’s not broadening out in the overall earnings picture.”
Earnings for companies in the S&P 500 Index are expected to climb 4.3% from a year ago. But strip out the so-called Magnificent Seven mega tech companies — Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc. — and the anticipated profit expansion nearly disappears, according to data compiled by Bloomberg Intelligence. Take out tech and communications more broadly, and the growth turns negative.
The outlook demonstrates just how reliant Corporate America remains on the technology profit machine. And it points to the pressure building on other industries to pick up at least some of the slack.
“The strongest earnings growth visibility is still coming from tech and communication services and parts of consumer discretionary sectors,” said Scott Chronert, head of US equity strategy research at Citigroup. “We need both — an ongoing conviction in earnings growth for the ‘growth’ cohort, and an ongoing improvement in trends for other sectors.
Looking at stock market returns, investors would be forgiven for thinking the rest of the equity universe is already posting strong results. While Big Tech drove the S&P 500 higher through the first half, sending their market valuations to record highs, things shifted in the third quarter as other sectors beat the growth giants.
In the third quarter, the Bloomberg Magnificent 7 Index trailed the equal-weight version of S&P, in which the weighting of each stock is the same regardless of the company’s market capitalization, for the first time since 2022. Within the S&P 500, utilities, real estate and financials have been the dominant sectors since the start of July, while information technology and communications services are barely in the green.
But the earnings tell a different story, with tech and telecom still the main drivers of growth. Wall Street analysts anticipate the Magnificent Seven’s third-quarter profits will be up more than 18% from a year ago. That’s a sizable drop from 37% year-on-year growth in the second quarter but still leading the S&P 500, where the remainder of the index is expected to be about flat. Indeed, without the tech and telecom sectors, S&P 500 companies are projected to post a decline in earnings growth, according to data compiled by Bloomberg Intelligence.
“While the S&P 500 excluding the Magnificent Seven is not seeing earnings growth, the valuation is far more attractive,” said Michael O’Rourke, chief market strategist at Jonestrading Institutional. “The Magnificent Seven names need to live up to high expectations to sustain their lofty valuations.”
Tech Drives Profits
Indeed, information technology and communications services are the only S&P 500 sectors expected to deliver double-digit earnings-per-share growth in the third quarter. The index as a whole is projected post 4.3% EPS growth, data from Bloomberg Intelligence shows. Of the S&P 500’s anticipated EPS of $60.26 in the third quarter, more than half is seen coming from the info tech sector.
It’s the same with revenues. In this case, information technology is the lone sector with an anticipated double-digit rise in the third quarter, according to Bloomberg Intelligence data. The S&P 500’s revenue growth is seen at 5.1%, and without technology it’s expected to be 4.4%, according to data compiled by BI.
What’s more, the outlook for Big Tech is considered strong, which is what investors are most interested in hearing about.
“The guidance from the mega-cap tech companies is expected to be positive,” said Adam Parker, founder of Trivariate Research. “If earnings estimates come up for this group following third-quarter results, it’s hard for the S&P 500 to go lower.”
That said, the forecast is encouraging for the entire market next year, with the Federal Reserve expected to continue reducing borrowing costs and the economy humming along. If the rest of the S&P still can’t deliver, however, the question becomes how much these companies can continue to contribute to the stock market rally.
“The Magnificent Seven names should have better profit growth regardless — they are high quality companies, near monopolies in many cases,” Jonestrading’s O’Rourke said. “The investor question is how much of premium multiple do they deserve relative to the rest of the market and does that premium place them at risk of disappointment. On the other side, the S&P 500 excluding the Magnificent Seven should be positioned for profit growth to resume as the Fed proceeds on its easing cycle.”
