Earnings Uncertainty Hits Tech Giants at Critical Market Juncture
Looking at the market right now, we are at an inflection point in the short term. Growth and tech stocks have been leading the market and should continue to do so in the future. There is still tremendous long-term value in these stocks in terms of expected EPS growth and profitability. However, in the short term, it is possible that we could be rotating into value stocks and small caps.
As companies began reporting second-quarter earnings a few days ago, the market outlook was positive, particularly for the S&P 500. Of the 14% of companies that had reported earnings as of Friday, 80% of them reported actual EPS above analyst estimates. The 10-year average of companies beating earnings is 74%, and the 5-year average is 77%, pointing to a strong start to the earnings season. However, more recent earnings have not followed this trend.
In particular, the Magnificent 7’s dominance is being called into question. The Magnificent 7 are seven innovative tech stocks that have performed well and driven market trends and innovation. Going into earnings season, four of the Magnificent 7 were expected to see an average earnings growth of 56.4%. Nvidia, Amazon, Meta, and Alphabet, in that order, are expected to be the top four contributors to year-over-year earnings growth. However, Google’s earnings report did not impress investors, even though they beat on top and bottom lines. Firstly, Google’s capital expenditures have been increasing and cash flows decreasing because of the AI buildout, which has investors worried. Additionally, YouTube ad revenue faltered, which is a very worrying sign for investors. This is generally considered a sign of a weakening consumer, as businesses have less money to advertise and consumers have less money to spend.
Additionally, Tesla’s EPS and sales fell short of earnings estimates. Following these reports, Tesla’s stock sharply fell as investors grappled with its loss of market share in the EV space and disappointing earnings. In total, the Magnificent 7 lost over $600 billion in market cap on Wednesday alone.
We see quite the opposite in the Russell 2000, an index made up of small caps, that many fund managers believe the market is rotating into. Many fund managers see the rising performance of this index as evidence of a rotation into small caps. However, 849 of the roughly 1,950 companies that reported earnings in the Russell 2000 have reported a negative EPS trailing 12 months. It remains to be seen if this rotation is going to become a trend, or if it is simply a result of institutional investors closing their short positions on the Russell.
This earnings season will be an inflection point, possibly marking a significant change in what has been driving the market. Will the Mag 7 continue to lead the market upward, or will earnings continue to disappoint and drag us down? Furthermore, is the shift into small caps and value stocks indicative of a genuine market rotation? With so many unknowns this earnings season, it will be interesting to see which direction the market will move in the coming weeks.
