By Lewis Krauskopf
NEW YORK (Reuters) – Hopes that the rise in U.S. stocks will extend beyond megacaps like Nvidia will be tested in coming weeks as investors learn whether profit growth from other companies is starting to catch up to that of technology-related leaders.
The S&P 500 is up 16% so far in 2024, driven by a handful of bullish stocks poised to take advantage of emerging artificial intelligence technology. Just 24% of stocks in the S&P 500 outperformed the index in the first half, the third narrowest six-month period since 1986, according to strategists at BofA Global Research.
Meanwhile, the equal-weight S&P 500 — a proxy for the average stock — is up only about 4% this year. As of Tuesday, about 40% of the S&P 500’s constituents were down for the year.
Second quarter earnings start next week with major banks including JPMorgan and Citigroup reporting on July 12. Investors will be watching to see if gains from other companies are catching up with the “Magnificent 7”: Nvidia, Microsoft, Apple, Alphabet, Amazon, Meta Platforms and Tesla, many of which returned from struggles in 2022.
Investors generally see a narrow rally as more fragile because weakness in just a few big stocks could sink the indexes, but some hope gains will spread through the second half.
More companies are expected to post improved earnings as many investors expect the economy to navigate a soft downturn, which could prompt stocks with more moderate valuations to trade than market leaders.
“If we’re looking for a catalyst to have a broader participation in this rally this year, the second quarter earnings reporting season could be the start of that,” said Art Hogan, chief market strategist at B Riley. Wealth.
The S&P 500 is trading at about 21 times forward earnings estimates, but if you exclude the top 10 stocks by market value, that figure drops to 16.5 on average for the rest of the index, Hogan said.
In a further sign of narrow growth, the information technology and communications services sectors, which comprise most of the Magnificent 7, are the only two of the 11 S&P 500 sectors to outperform the broader index this year .
Earnings among the Magnificent 7 rose 51.8% year over year in the first quarter compared with 1.3% earnings growth for the rest of the S&P 500, according to Tajinder Dhillon, senior research analyst at LSEG.
That gap is expected to narrow, with forecasts for 7-year Madhe earnings to rise 29.7% in the second quarter and earnings among the rest of the index rising 7.2%, according to LSEG.
“We think a greater balance in profitability could lead to broader market participation in the coming quarters,” Chris Haverland, global equity strategist with Wells Fargo Investment Institute ( WFII ) said in a note on Tuesday ).
WFII suggests investors cut gains in the technology and communications services sectors to take advantage of weakness in energy, healthcare, industrials and materials.
Later in the year, Magnificent 7’s earnings lead is expected to narrow further. The group’s year-on-year earnings growth is expected to be 17.4% in the third quarter and 18.3% in the fourth. This compares with revenue growth from the rest of the index of 6.8% in the third quarter and 13.9% in the fourth quarter.
“We anticipate that we will have nearly all S&P sectors participating in earnings growth in 2024,” said Katie Nixon, chief investment officer for Northern Trust Wealth Management.
Not everyone is convinced that other groups are ready to catch up, as AI remains a dominant topic. Robert Pavlik, senior portfolio manager at Dakota Wealth Management, said he had doubts about earnings growth meeting expectations, due to weak consumer spending, rising inflation and other economic indicators.
Data on Friday showed that US job growth slowed marginally in June, with major stock indexes little changed in morning trade after the report.
In the coming days, investors may get a clearer picture of the health of the economy and when the Federal Reserve will begin cutting interest rates, which could also trigger broader market gains. Fed Chairman Jerome Powell will testify before Congress on Tuesday, while the release of the monthly consumer price index on Thursday provides a crucial look at inflation.
(Reporting by Lewis Krauskopf; Editing by Michelle Price and David Gregorio)