As the quarterly earnings season for U.S. companies enters its final stretch, one thing is becoming clear: The long-awaited recovery for companies that were overlooked during the artificial intelligence craze is finally beginning.
The signs of change are hard to ignore. For many quarters, profit growth at the seven largest tech companies has driven gains in the S&P 500 Index. That’s about to change, as the rest of the benchmark, excluding the so-called “Fabulous Seven,” are on track to post their first profit growth since the fourth quarter of 2022, data compiled by Bloomberg Intelligence show.
“This broader earnings strength is a positive because it gives portfolio managers more exposure beyond a few stocks and creates a more balanced market,” said Keith Lerner, co-chief investment officer at Truist Advisory Services.
Although more than 80% of S&P 500 members have reported, key indicators of U.S. consumer health — such as Home Depot LLC, Walmart Inc. and Target Corp. — has yet to release its numbers. The clues it reveals about consumer spending will be closely watched as traders remain concerned about the possibility of a recession. Additionally, Nvidia Corp., arguably the most important stock for investors interested in artificial intelligence, is scheduled to report later this month.
Here are some highlights of the earnings season so far:
Expanding growth
Most notably, large-cap earnings growth is slowing, while smaller companies are starting to pick up steam.
Earnings for S&P 500 companies, excluding the Magnificent Seven, are expected to have risen 7.4% in the second quarter from a year earlier, after five straight quarters of declines, BI data shows. Profits for large-cap tech — Apple LLC, Microsoft Company, Alphabet LLC, Amazon.com LLC, Meta Platform LLC, Tesla Inc. and Nvidia — are expected to grow 35%. That’s certainly a fast pace of growth, but it represents a significant slowdown from the even greater growth seen over the past year.
Earnings strength spilling over into the broader market could fuel a strong rotation from large-cap stocks to smaller companies and market laggards. Investor change The first was boosted by lower-than-expected inflation in July.
“The earnings expansion theme is a big part of why we think equity performance will extend beyond Mag-7 this year,” said Stuart Kaiser, head of equity trading strategy at Capital Economics. Citigroup Inc. Inc. “More companies generating earnings will make EPS growth less scarce and support broader participation in stock performance. That has only happened in waves this year, which is frustrating for investors.”
AI enthusiasm wavers
The big disappointment comes from a corner where both expectations and stock valuations are high. Results so far from major players in artificial intelligence have been lackluster, raising concerns that the billions of dollars invested in AI may not be coming soon. Amazon.com, Microsoft and Alphabet all are disappointed, with their views either falling short of expectations, or lacking specifics.
“The risk is that without the revenue boost, companies get a little nervous and may cut back on AI projects (or) spending,” said Bloomberg Intelligence strategist Michael Casper. “Especially if the economy is weakening and they have to maintain high margins, AI spending will be the first thing to be curtailed because it generates less revenue.”
Facebook parent Meta bucked the trend, citing the power of AI as its second-quarter revenue beat expectations. Apple also said new AI features will drive iPhone upgrades in the coming months, helping the company weather a sales slowdown. Nvidia, the biggest beneficiary of AI spending, reported on Aug. 28.
Savita Subramanian, equity and quantitative strategist at Bank of America“Those with a clear tendency to make money were rewarded, while others were punished.”
In short, she says: “The days of hype around AI are over. It’s now a ‘show me’ story.”
Serious revenue shortfall
While earnings have been a bright spot, revenue misses have become more frequent this time around, drawing the attention of market watchers. Companies have reported revenue that missed estimates 21% of the time, compared with 20% a year ago, according to data compiled by Bloomberg Intelligence.
“Overall earnings beat rates are near long-term averages, but revenue beat rates are below average,” said Truist’s Lerner. “So companies are using other levers, like on the expense side, to get their numbers.”
Prospects improve
Overall, executives expressed optimism about future earnings, with BI data trending positive in the third quarter. In fact, a measure of earnings guidance momentum—derived in part from the ratio of upward versus downward guidance—is expected to be positive in the July-September period for the first time since 2021.
Data from Bank of America shows a similar trend. Strategist Subramanian notes that analysts’ median estimates for both 2024 and 2025 are holding steady. “This suggests that analysts are quite comfortable with their estimates,” she says.
Stock reaction was fierce.
This is a volatile earnings season for stocks. Both good and bad news cause a more dramatic reaction in the stock market than usual.
Citi data shows that the average S&P 500 company reporting second-quarter earnings so far has moved 4.9% in either direction on the day of the announcement. That’s well above the historical average of 3.3%. What’s more, the data shows that earnings-day moves in just one direction — up or down — are also the largest in 12 years.
