Earnings growth in US finally showing up outside tech mega-caps

As another quarterly earnings season from corporate America enters its final stretch, this much is clear: The long-awaited recovery in the companies that were left out of the artificial intelligence (AI) frenzy has finally begun.

Signs of the turnaround are unmissable. For several quarters, profit growth in the seven biggest technology companies was driving gains for the S&P 500 index. That is about to change, as the rest of the stocks in the benchmark, excluding the so-called “Magnificent Seven”, are on pace to deliver their first profit growth since the fourth quarter of 2022, data compiled by Bloomberg Intelligence (BI) shows.

“This broader earnings strength is a positive as it provides portfolio managers more opportunities beyond just a few stocks, and provides a more balanced market,” said Mr Keith Lerner, co-chief investment officer at Truist Advisory Services. 

Though more than 80 per cent of the S&P 500 members have already reported their results, major bellwethers for the health of US consumers – such as Home Depot, Walmart and Target – have not yet announced their numbers.

The clues they reveal about consumer spending will be closely watched as traders remain jittery about the possibility of an economic slowdown. Also, Nvidia, which is arguably the most important stock for investors interested in AI, is scheduled to report earnings later in August.

The biggest takeaway so far has been slowing profit growth of large-cap companies, as smaller names started to hit their stride.

The BI data shows that earnings for S&P 500 companies, excluding the Magnificent Seven, are set to grow 7.4 per cent in the second quarter from the same time a year ago, after five straight quarters of decline.

Profits for the mega-cap tech group – Apple, Microsoft, Alphabet, Amazon.com, Meta Platforms, Tesla and Nvidia – are set to rise 35 per cent. It is a brisk pace, to be sure, but one that represents a sharp slowdown from even bigger gains over the past year.

Earnings strength spreading out to the wider market could add more fuel to what has already been a drastic rotation away from large-cap stocks and into smaller companies and market laggards. The investor shift was first sparked by a cooler-than-expected inflation read in July.

“The broadening-of-earnings theme was a key part of why we thought equity performance would broaden out beyond the Mag-Seven this year,” said Mr Stuart Kaiser, head of equity trading strategy at Citigroup.

“More companies generating earnings would make earnings per share growth less scarce and support broader participation in stock performance. That has happened only in fits and starts this year for the most part, which has been frustrating for investors.”

The big disappointment came from just the corner where both expectations and stocks valuations have been running high.

Results so far from the major players in AI have been lukewarm at best, spreading concern that returns from billions of dollars in AI investments may not come any time soon. Amazon.com, Microsoft and Alphabet all disappointed, with their outlooks either missing expectations, or being short on specifics.

“The risk is that because there hasn’t been that boost to revenues, companies are getting a little antsy and might cut back on AI projects (or) spending,” said BI strategist Michael Casper. “Especially if the economy is weakening and they’ve got to keep margins up, AI spend will be the first thing to get curbed because it generates little revenue.”

Facebook parent Meta bucked the trend, citing strength in AI as its second-quarter revenue beat expectations. Apple also said new AI features will spur iPhone upgrades in the coming months, helping it re-emerge from a sales slowdown. Nvidia, the biggest beneficiary of AI spending, reports its earnings on Aug 28. 

“The key focus for hyperscalers this quarter was AI monetisation,” said Ms Savita Subramanian, equity and quant strategist at Bank of America (BOA). “Those with clear monetisation trends have been rewarded, while others have been penalised.”

In short, she said, “AI hype days are over. Now it’s a ‘show me’ story”.

While earnings have been a bright spot, revenue misses have been more frequent this time around, grabbing the attention of market watchers. Companies reported revenue below estimates 21 per cent of the time, compared with 20 per cent a year ago, according to BI data.

“The overall earnings beat rates are running close to the long-term average, but the revenue beat rate is below average,” Truist’s Mr Lerner said. “Thus, companies are pulling other levers, such as on the expense side, to meet their numbers.”

Overall, executives expressed optimism for future earnings, with BI’s data trending positive for the third quarter. In fact, the gauge of earnings guidance momentum – derived in part from the ratio of increased versus reduced guidance – is expected to be positive in the July-to-September period for the first time since 2021.

BOA data showed the same trend. Ms Subramanian noted that analysts’ average estimates for both 2024 and 2025 are holding up. “This suggests that analysts are relatively comfortable with their estimates,” she said.

Still, it has been a volatile earnings season for share prices. Both good news and bad news were met with intense stock reactions, more so than usual.

Data from Citi found that the average S&P 500 company posting second-quarter earnings has so far moved 4.9 per cent in either direction on the day of the announcement. That is well above the historical average of 3.3 per cent. Moreover, earnings-day moves in just one direction – higher or lower – were also the widest in 12 years, the data shows. BLOOMBERG