The S&P 500 Has Survived Big Tech's Slide as the 'other 493' Have Caught Up

The stock market has managed to recover most of the losses incurred during its summer downturn. However, unlike previous rebounds, this recovery isn't driven by Big Tech. Instead, sectors such as real estate, utilities, and consumer staples are now taking the lead. For much of the past two years, technology giants like Nvidia Corp. and Microsoft Corp. have been at the forefront of the S&P 500 Index's gains, attracting investors with their robust profits and significant exposure to artificial intelligence. But as concerns over slowing economic growth rise and the Federal Reserve prepares to cut interest rates, traders are shifting their focus to other sectors.

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Since the S&P 500 reached its peak on July 16, the so-called "Magnificent Seven" tech stocks—Nvidia, Microsoft, Apple Inc., Alphabet Inc., Amazon.com Inc., Meta Platforms Inc., and Tesla Inc.—have mostly experienced declines. The Bloomberg Magnificent 7 Index has dropped by 5.3% during this period. While the broader S&P 500 is down by less than 1%, largely because of the index's heavy weighting toward these tech giants, traditionally stable sectors like real estate and utilities have surged, each gaining around 11%.

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These trends include last week's rally in the S&P 500, which was again led by the tech sector. "Investors love to look at companies that are going from earnings declines to earnings gains," said Michael Casper, an equity strategist at Bloomberg Intelligence. "That’s kind of leading them away from tech and to the other 493 stocks that were cast aside."

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This rotation is partly driven by expectations of monetary policy easing, but it's also a sign of an improving profit outlook for sectors outside of tech. The extensive spending by tech giants has sparked concerns about their profit margins, making other sectors more attractive. Whether this shift represents a short-term blip or a longer-lasting trend depends on the direction of the economy. The Federal Reserve's upcoming decision on interest rates, with traders split between a quarter-point and half-point reduction, will provide further insights.

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"We don’t believe we’re going into a recession, and the stocks that will begin to show leadership are the cyclicals that will benefit from higher economic growth and lower interest rates," said Adam Grossman, Chief Investment Officer for global equities at Riverfront Investment Group. Despite this belief, his firm continues to hold a significant position in large-cap tech stocks. On the other hand, if the economy deteriorates, defensive sectors like utilities and consumer staples are likely to benefit, although this environment could also support tech stocks.

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"If there’s some uncertainty, our view is investors will continue to pay a premium for growth prospects," said Keith Lerner, Co-Chief Investment Officer at Truist Advisory Services. "If things continue to slow down, defensive sectors would continue to do well. In either environment, slowdown or still some stability, I think tech does well."

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One factor contributing to the success of sectors outside of tech is an improving earnings outlook. For instance, the health care sector, which had seen shrinking profits for seven consecutive quarters, experienced a 16% earnings increase in the second quarter. According to Bloomberg Intelligence data, this growth trend is expected to continue, with profits projected to reach 45% by the first quarter of 2025.

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However, tech earnings, while still strong, are not growing as rapidly as they were in the past two years. During that period, tech companies benefited from steady sales growth and a focus on efficiency, which led to significant job cuts across the industry. The "Magnificent Seven" companies posted a 36% profit growth in the second quarter, impressive but lower than the over 50% growth seen in the previous three quarters. According to Bloomberg Intelligence data, their earnings are expected to grow between 17% and 20% over the next four quarters.

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Part of the recent selloff in Big Tech stocks is related to the companies' substantial spending on AI computing infrastructure. In the last quarter alone, Amazon, Google-parent Alphabet, Microsoft, and Meta Platforms invested more than $50 billion combined in capital expenditures. Nvidia, whose semiconductors are essential for AI model computations, has been a significant beneficiary of this spending. However, this aggressive investment strategy has raised concerns among investors about the profit margins of Nvidia's biggest customers, especially since there are few indications that this spending will result in the level of revenue growth needed to justify such large expenditures.

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While the recent downturn has reduced the valuations of many tech stocks, they remain relatively high. For example, Microsoft is currently priced at 32 times its projected profits for the next 12 months, down from a peak of 35 in July but still well above its 10-year average of 25. In comparison, other market sectors offer cheaper valuations, which could continue to draw investor interest. However, this does not imply that technology stocks won't perform well. Despite concerns about an AI bubble, Michael Mullaney, Director of Global Market Research at Boston Partners, argues that tech companies are fundamentally different from those of the dot-com era.

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"The other 493, being a lot cheaper, probably do get a bit of a bid, but it doesn’t mean you throw the baby out with the bathwater," Mullaney stated. "These companies are printing money hand over fist. That’s a big difference from 2000."

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In summary, the stock market's recent rebound marks a shift in investor focus away from Big Tech toward sectors with improving earnings prospects. While tech stocks remain strong, concerns over profit margins and high valuations are prompting investors to explore opportunities in other areas of the market. As the Federal Reserve's monetary policy and economic conditions evolve, the direction of this rotation will become clearer, but for now, it represents a more balanced approach to equity investment.

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