Quick Look:
- Wall Street’s earnings season underperformed, sparking doubts about the AI boom’s profitability.
- Major tech stocks fell sharply, significantly dropping the S&P 500 and Nasdaq 100 indices.
- Due to market concentration risks, investors are shifting away from mega caps and favouring smaller companies.
- Expectations of the Federal Reserve’s interest rate cuts are influencing market trends and investor sentiment.
- Economic data and scepticism about AI’s immediate returns drive the ongoing shift away from tech stocks.
Wall Street faced a stark reality check as the much-anticipated start of the mega-cap earnings season did not meet expectations. This disappointing performance has fuelled concerns that the artificial intelligence (AI) boom, a significant driver of the bull market, might be more hype than substance. The selloff in significant tech stocks has sent shockwaves through the market, with the S&P 500 experiencing its worst day since December 2022 and the Nasdaq 100 tumbling over 3.5%.
The S&P 500’s Unwelcome Record
The S&P 500’s decline marked the end of its longest streak without a 2% drop since the onset of the global financial crisis. This selloff was particularly pronounced among extensive tech stocks, with Alphabet Inc. sliding 5% due to higher-than-expected spending on its AI initiatives. Tesla Inc. also took a hit, with a 12% stock plunge following a profit miss and delays in its Robotaxi project. This reaction highlights investors’ growing scepticism about the immediate profitability of AI investments.
Shifting Tastes: From Megacaps to Smaller Companies
Investors are increasingly wary of the concentration risk in the market, where a few mega-cap stocks have disproportionately driven gains. Over the past four sessions, and in 10 of the last 11 days, smaller companies have outperformed their larger counterparts. This shift indicates a change in investor preferences, moving away from the tech giants that have dominated benchmark indices. The broader market’s performance suggests a more cautious approach as investors seek to diversify their portfolios amidst uncertainty.
Federal Reserve’s Role in Market Dynamics
The Treasury yield curve has steepened on expectations that the Federal Reserve might soon cut interest rates. Former New York Fed President William Dudley has advocated for lower borrowing costs, potentially as soon as the next meeting. However, some analysts worry that such a move could signal an impending recession, raising further concerns about the economic outlook. Meanwhile, international markets have also reacted, with the Canadian dollar falling after a rate cut by the Bank of Canada and the yen reaching its highest level since May.
AI Bubble: Waiting for the Burst
Steve Clayton of Hargreaves Lansdown has dubbed this year where markets might start talking about the “So-So Seven,” referencing the tepid results from tech giants like Tesla and Alphabet. Kathleen Brooks from XTB echoed this sentiment, stating that the initial earnings from these companies still need to provide clear answers about AI’s profitability. This cautious outlook is causing traders to rotate out of mega caps and into other market sectors, driven by bets on potential Fed rate cuts and lingering doubts about AI’s immediate payoffs.
Tech Stocks: The Rotation Trade’s Impact
Tech stocks are currently caught in a rotation trade that began with the June Consumer Price Index (CPI) report. According to Adam Crisafulli of Vital Knowledge, many assumed this rotation away from tech would be short-lived. However, its persistence is adding to the anxiety and selling pressure on tech stocks. This market shift has deflated some of the high valuations in tech, which might attract dip buyers. Nonetheless, the earnings season is just beginning, with key reports from Apple Inc., Microsoft Corp., Amazon.com Inc., and Meta Platforms Inc. due soon.
A Weaker Start to Earnings Season
The US earnings season has started on a weaker note compared to previous quarters. Among the S&P 500 companies that have reported, profits have exceeded analyst estimates by the smallest margin since late 2022. Sales surprises have been the worst in at least two years. Analysts such as Dan Wantrobski of Janney Montgomery Scott predict increased volatility in the second half of 2024. They foresee potential corrections in critical benchmarks like the S&P 500 and Nasdaq 100. While a significant downturn is not expected, a pause in the current expansion cycle appears likely.
The 200-Day Moving Average: A Key Indicator
As earnings reports continue to roll in, a crucial technical indicator in the US stock market, the 200-day moving average (200-DMA), is nearing historical extremes. Last week, the S&P 500 was trading up to 15% above its 200-DMA, a gap that has since narrowed but remains a warning sign. Historically, such a wide gap has preceded market declines, raising concerns about high-tech valuations and concentration risks. While this does not guarantee an imminent market crash, it serves as a cautionary signal for investors navigating the volatile waters of the current market landscape on Wall Street.
