Thursday could be called the “revenge of the diversified portfolio.” It wasn’t so much a negative day for tech stocks, as advancers outnumbered decliners by 6-to-1 on the NYSE, but rather a positive day for diversification, due to the strong gains in cyclicals, interest-sensitive stocks, and bank stocks. Here’s one key question: Was it more than just a one-day miracle? Certainly lower interest rates are a big help, especially for small caps that are sensitive to interest-rate fluctuations. The belief that the economy is slowing but still strong is also key to the belief that the Fed will cut interest rates starting in September. But without earnings, all of this means nothing. There has to be confidence that earnings will extend beyond a few large tech stocks. The root cause of the secular tech rally is superior earnings growth in technology. Two questions come to mind: Is most or all of that earnings growth priced in in the big tech rally, and what is the outlook for earnings growth in other sectors? When it comes to earnings, it’s not just whether earnings will go up or down, but by how much. What is the rate of change? For mega-cap tech stocks, as I pointed out two weeks ago, while mega-cap tech earnings continue to grow, the rate of change in earnings growth has slowed, especially for market leaders like Nvidia. This is a warning sign for investors who continue to put money into mega-cap tech. Non-tech earnings growth strategists are already getting out ahead of this. “We expect the rest of the market to close the gap with mega-cap tech, which means earnings are spreading out,” Supriya Menon, head of multi-asset strategy EMEA at Wellington Management, said in an interview on Bloomberg TV. “Looking forward, we see the big tech companies settling down in terms of the earnings they can achieve in the next few quarters.” Bank of America’s Savita Subramanian is also in the “expansion” camp. “Q2 is expected to be the first quarter of EPS growth since Q4 2022 for the other 493 companies, while growth for the major seven companies is expected to slow for the second consecutive quarter and slow again in Q3. Growth is expanding, and so should the market,” Subramanian said. It’s great to be optimistic about earnings growth. The question is identifying where this additional earnings growth will come from and how robust it will be. Consumer stocks aren’t growing at all. In a recent note, Bank of America consumer analyst Brian Spillane said, “Demand remains stubbornly weak across our consumer staples coverage segments.” With the exception of weight loss drugs, so is healthcare. While the big banks are performing well, regional banks are struggling due to deposit outflows, sluggish loan growth and exposure to commercial real estate. If revenue is driving earnings, it’s hard to be optimistic. Even Subramanian acknowledges that “excluding Mag7, consensus expects underlying sales growth to be just 1% higher in the second half.” Putting all this together, Bank of America’s Global Sales Advisory Desk concluded in a note yesterday that “it’s not yet paying off to be experimental.”
