AI Led The Surge, Utilities Joined Later

In recent weeks, several under-the-radar sectors have been propelling the stock market higher, setting the stage for a test of their resilience. The S&P 500 has gained 21% this year, with tech giants and their AI ambitions fueling the first-half surge.

  • However, as the third quarter progresses, utilities, materials, and industrials have taken the lead in broadening the rally.
  • The upcoming earnings season is expected to reveal whether this expanded market rally can be sustained. Wall Street forecasts that earnings for the "Magnificent Seven" tech giants will rise by 17.5% in the third quarter compared to a modest 1.1% increase for the remaining S&P 500 companies.

This marks the smallest gap between tech and the rest of the market since early 2023.

Accelerating Earnings

Tech sector dominance is waning as growth decelerates, but earnings in other areas are beginning to accelerate. Economic optimism is driving gains across industries. September's employment data showed strong hiring and a dip in the unemployment rate to 4.1%, while inflation has been easing. The resolution of the recent port strike also allayed supply chain concerns. Additionally, the Federal Reserve’s rate cut in September could further support the economy.

  • Overall, S&P 500 companies are expected to post a fifth consecutive quarter of earnings growth, with a projected 4% year-over-year increase in profits for Q3.
  • Major banks such as JPMorgan Chase, Wells Fargo, and asset manager BlackRock are among those set to report results this week, alongside key inflation data, which could sway the Fed’s interest rate strategy.

While tech stocks remain the biggest contributors to earnings growth, with the information-technology sector expected to grow profits by 15%, other sectors are showing promise. Healthcare is forecast to post an 11% earnings increase, and both real estate and utilities are projected to rise by 5% and 3.8%, respectively. In contrast, the energy sector, which thrived on last year’s higher oil prices, is expected to see a 24% decline in profits.

Caution Remains

Despite the broadening rally, investors remain cautious as they await updates on the Middle East conflict and the upcoming U.S. presidential election. These geopolitical and political uncertainties could impact market sentiment, notes Lauren Goodwin, chief market strategist at New York Life Investments.

  • Some companies are already showing signs of struggle. FedEx shares dropped 15% in late September after reporting lower revenue and cutting its outlook, while Nike saw a 6.8% decline following a report of falling profits, partially due to weaker demand for its limited-edition sneakers.
  • With the S&P 500 trading at a premium valuation of 21.4 times projected earnings over the next 12 months, compared to the 10-year average of 18.3, disappointing earnings results could make stocks appear overpriced.

However, Wall Street remains optimistic for the year, forecasting a 10.2% rise in S&P 500 profits.

Disclaimer

Please note that Benchmark does not produce investment advice in any form. Our articles are not research reports and are not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

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Photo by Tomas Eidsvold / Unsplash.