Stocks Look Set to Extend Record Run Ahead of Tech Earnings

The stock market is approaching a period of uncertainty, which has left some investors feeling nervous. Over the coming days, several major tech companies, whose stocks have driven the market to record highs, will release their earnings reports. Analysts will closely examine these reports, focusing on the companies' significant investments in artificial intelligence (AI) and attempting to gauge when those bets on AI will begin to pay off.

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While the market's rally has broadened in recent months, including gains in sectors such as utilities, industrials, and financials, the largest tech companies still wield significant influence over the direction of the S&P 500. A key point of interest is the "Magnificent Seven" group of big tech companies, which, according to a FactSet analysis, is expected to contribute nearly all the earnings growth from the S&P 500 for the third quarter. This makes their results critical for determining the next phase of the rally.

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Nicholas Colas, co-founder of DataTrek Research, remarked that the S&P 500 is heavily reliant on these tech giants. He referred to it as both a blessing and a curse, as the fortunes of a few companies have an outsized impact on the index.

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Meanwhile, investors are preparing for potential upheaval as the U.S. presidential election approaches. Some hedge funds and money managers, believing that former President Donald Trump could be making a return to the White House, have made financial bets that they believe will benefit from his re-election. With the race between Trump and Vice President Kamala Harris being close, other investors are bracing for the possibility that the election outcome might not be clear on election night, prolonging the market’s uncertainty. This uncertainty surrounds issues like taxation and regulations that businesses will face, adding further volatility to an already tense market environment.

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Stephanie Lang, the chief investment officer at Homrich Berg, predicted that there would be considerable volatility both leading up to and following the election. She highlighted how the market’s uncertainty would likely persist until the results are known, affecting market stability.

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Currently, stocks are trading near all-time highs and are considered to be at some of their most expensive valuations in years. The S&P 500 has reached 47 record closes in 2024, including four this month, and is up by 22% for the year. According to FactSet, the index has been trading at more than 22 times its projected earnings for the next 12 months, marking its highest multiple since April 2021.

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However, optimism among some investors has begun to fade. A recent survey by the American Association of Individual Investors revealed that bullish sentiment—expectations that stock prices will continue to rise over the next six months—dropped to its lowest level since April, when the S&P 500 experienced its last losing month.

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Another factor weighing on stocks is the recent rise in government bond yields. Higher bond yields typically make equities less attractive due to the increased risk they carry in comparison. Last week, the 10-year U.S. Treasury note yield hit 4.24%, its highest close since July. This marked a significant increase from mid-September, when yields had been as low as 3.62%.

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Analysts attribute the rise in yields to stronger-than-expected economic data, which suggests that the Federal Reserve may cut interest rates more slowly than anticipated. There is also speculation that investors might be betting on a Trump victory in the election, which could result in larger budget deficits and an increased supply of Treasurys.

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The earnings season for the "Magnificent Seven" tech companies began with Tesla last week, showcasing just how much attention the market pays to these giants. Tesla’s shares surged by 22%—its best performance since 2013—after the company posted better-than-expected earnings.

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This week, Google parent Alphabet will report earnings on Tuesday, followed by Microsoft and Facebook parent Meta Platforms on Wednesday. Apple and Amazon are scheduled to release their results on Thursday. Nvidia, the final member of the Magnificent Seven, will report its earnings on November 20.

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During the last earnings season, concerns started to arise regarding the tech giants’ massive investments in AI. Amazon, in particular, saw its shares drop significantly after projecting weaker-than-expected sales growth and revealing plans to increase spending to meet AI demand. Alphabet and Microsoft also experienced declines in their stock prices following their earnings reports.

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Aaron Clark, portfolio manager at GW&K Investment Management, described the balancing act that tech companies face. They need to spend on AI development while maintaining investor confidence that these expenditures will eventually generate revenue. Spending too much could cause the market to worry, and that’s the delicate line these companies are trying to navigate.

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Despite these concerns, analysts predict that profits from the Magnificent Seven will have grown by 18.6% in the third quarter, compared to just 0.2% growth from the rest of the S&P 500 companies.

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However, this doesn’t necessarily signal a return to the tech-heavy trading environment seen earlier in the year. Looking ahead, markets are anticipating that the other 493 companies in the S&P 500 will deliver double-digit profit growth in the coming quarters. Investors see this as a positive sign for the sustainability of the rally, with Julie Biel, chief market strategist at Kayne Anderson Rudnick, pointing out that relying on just a few companies for growth is not conducive to long-term stability.

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Economists are optimistic about the broader economy, with recent data showing that inflation has cooled to a three-year low, and the Federal Reserve has started to lower interest rates. This creates a scenario where companies beyond the AI spotlight could also perform well, setting the market up for potential success in the coming months.

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