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Big Tech fuels S&P rally, others need to follow suit soon

Big Tech’s relentless growth has been an article of faith for investors since the last stock market rally began in October 2022.

But with uninspiring earnings prospects for the rest of 2024, other corners of the market will likely be needed if share prices continue to rise.

“To get comparable returns for the market in the second half of the year, you need broader participation,” said Keith Lerner, co-chief investment officer and chief market strategist at Truist Advisory Services.

That seems like this could happen. While Big Tech’s earnings growth is expected to slow dramatically from here on out, sectors like basic materials and healthcare are expected to see earnings growth of around 25% in the fourth quarter after shrinking 20% ​​or more in the first quarter. have booked.

“I think these sectors are starting to look quite interesting, and I’m talking about energy, materials, consumer discretionary, industrials and financials,” said Ohsung Kwon, equity and quantitative strategist at Bank of America. “I think all those cyclical sectors will do better in the second half of the year.”

That rotation appears to be already underway. At BofA, clients withdrew nearly $2.2 billion from technology stocks in the week ending May 31, the second-highest in the bank’s data going back to 2008. The largest client inflows went to the consumer discretionary sector, which saw this year has increased by 1.9%. making it the second-worst performer in the S&P 500.

“Discretionary investing has historically been a big driver of S&P 500 gains and tends to slow things down,” said Michael Casper, an equity strategist at Bloomberg Intelligence.

Can’t quit technology
None of this is to say that investors will or should give up on Big Tech. The S&P 500 is up 12% this year, with the top five stocks — Microsoft Corp., Apple Inc., Nvidia Corp., Alphabet Inc. and Amazon.com Inc. – are responsible for more than half of those gains, while markets are fascinated by the boom in artificial intelligence.

In addition, these five companies will add a combined $2.9 trillion in market value by 2024. That has helped information technology become by far the largest sector in the S&P 500, with a 31% weighting. The next closest groups are financial and healthcare, at around 12%.

Moreover, it is not the case that technology companies are done growing. It’s just that the pace of their profit growth is slowing. After three straight quarters of earnings growth above 44%, the S&P’s five largest companies are expected to see that figure fall to 29% in the second quarter before hitting the teens in the second half of the year, it shows from data collected by BI. .

“We still think Big Tech is likely to outperform, but at a more moderate level,” Lerner said. “Investors will hold on to these companies, which are high quality, have strong cash flow and have a lot of cash on the balance sheet.”

In many ways, the companies are suffering from their past success, as their strong 2023 results make for challenging comparisons to 2024. But the companies are still increasing profits and generating healthy margins after aggressive cost cutting.

‘High expectations’
“It’s up to Big Tech to meet the high expectations,” said Adam Sarhan, founder of 50 Park Investments. “Otherwise, the stock market will be forced to recalibrate and sell off, especially if other sectors’ earnings growth does not improve from here.”

Part of the challenge for technology investors is that the stocks are already quite expensive. Nvidia has a price tag of 40 times expected earnings for the next twelve months, compared to 21 times for the S&P 500. Microsoft is at 33 times and Apple at 29 times. Even Alphabet, which is relatively cheaper at 21 times, has been trading above average over the past decade.

“As these non-tech sectors start to grow their profits, the premium investors paid for technology should decline relatively speaking compared to other sectors,” BofA’s Kwon said.

An asymmetry is also emerging toward Big Tech stocks as the companies’ earnings prospects diverge.

With investors focused on AI, Nvidia has surged ahead of the rest, up 144% this year and remains the best performer in the S&P 500. Facebook parent Meta Platforms has added 39%, while Google parent Alphabet is up 25% and Amazon is up 21%. Microsoft, on the other hand, hasn’t really kept pace with a relatively meager 13% increase. And then there’s struggling Apple, which was in the red for most of the year and is up just 2.3% in 2024.

“The fundamental business units of each of these companies are no longer moving in the same direction as they were during the pandemic recovery, so that is also cooling earnings,” BI’s Casper said. “The Magnificent Seven’s shares no longer move as one ubiquitous bloc, and that’s hurting earnings potential as a cohort because trading is now broken up.”

Choose sectors
However, counting on a rise in the rest of the market comes with its own risks. Margins in healthcare, for example, are shaky despite enthusiasm for anti-obesity drugs, as the group continues to grapple with charges from big pharmaceutical companies. Meanwhile, the consumer discretionary sector’s earnings growth is driven by just a handful of companies, such as Amazon and Home Depot Inc.

That means more sectors outside these sectors will need to post profit growth, especially consumer discretionary sectors and sectors closely tied to the health of the economy: manufacturing and finance, Casper said. However, there are risks associated with each of these groups.

“The consensus earnings forecasts are pretty bad for most retailers not named Amazon,” he said. “Financial and industrial sectors could pick up their pace, although regional banks are still dealing with a hangover from (the collapse of Silicon Valley Bank).”

Ultimately, the stock market’s success in 2024 may still be due to Big Tech, directly or indirectly. With AI expected to have a transformative impact on so many sectors, technological development is likely to spill over into other parts of the economy, sending those stocks higher along the way.

“As long as Big Tech companies continue to deliver on their earnings prospects, that bodes well for the economy,” said 50 Park’s Sarhan. “Which will further fuel the stock market rally as there are other industries outside of technology that will benefit from AI.” Bloomberg

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