In recent weeks, lesser-known sectors of the stock market have taken the lead, driving a rally that will soon face its next big challenge. While the S&P 500 has climbed 19% so far this year, much of that gain earlier in 2024 was fueled by major tech companies, especially those heavily invested in artificial intelligence. However, since the third quarter began, sectors like utilities, materials, and industrials have stepped up to sustain the market’s momentum, shifting the spotlight away from tech.
The upcoming earnings season could determine whether this broader market rally is sustainable. Analysts are watching closely to see if the rest of the market can continue to narrow the earnings gap with tech giants. Wall Street expects earnings for the so-called “Magnificent Seven” tech firms to grow by 17.5% in the third quarter compared to a year ago. By contrast, the other 493 companies in the S&P 500 are only expected to see a 1.1% rise in profits. Despite this disparity, this would represent the smallest earnings gap between the two groups since early 2023.
“The tech giants are seeing their earnings slow from a very high base, while the rest of the market is picking up,” said Lauren Sanfilippo, senior investment strategist at Bank of America’s Chief Investment Office. She added that investors will be looking for signs that the broader market’s earnings growth can continue.
Several factors are fueling optimism across industries. The latest economic data shows strong job growth, with the unemployment rate falling to 4.1% in September. Inflation has been easing, and supply chain threats from a recent port strike have been averted. Additionally, the Federal Reserve’s recent rate cuts in September are expected to provide more support to the economy.
For the third quarter, companies in the S&P 500 are on track to report their fifth consecutive quarter of earnings growth, with an expected overall increase of 4%, according to data from FactSet.
Some of the largest U.S. banks and asset management firms, including JPMorgan Chase, Wells Fargo, and BlackRock, are set to report their earnings this week. Investors will also be watching new inflation data, which could influence the Federal Reserve’s next moves on interest rates.
Tech stocks, particularly those in the information technology and communication services sectors, remain top contributors to third-quarter earnings. Companies like Nvidia and Apple in the IT sector are expected to report a 15% earnings increase, while Meta and Alphabet in the communication services sector are forecast to post a 10% rise. Meanwhile, sectors like healthcare, real estate, and utilities are expected to deliver more modest earnings growth of 11%, 5%, and 3.8%, respectively. The energy sector, which saw significant gains from higher oil prices last year, is projected to suffer the biggest profit decline, down 24%.
This broader rally has made stocks pricier, with companies in the S&P 500 now trading at 21.7 times their projected earnings over the next 12 months, higher than the 10-year average of 18.3.
While Wall Street remains optimistic about the year overall—anticipating a 9.7% increase in profits for S&P 500 companies—the focus will now shift to how well non-tech sectors can perform in the third quarter.
Michael Arone, chief investment strategist at State Street Global Advisors, is particularly interested in seeing whether other sectors can outperform. “That would suggest that the earnings growth gap between tech and the rest of the market could continue to shrink going forward,” Arone said.
With looming uncertainties, such as the escalating conflict in the Middle East and the upcoming U.S. presidential election, corporate outlooks in the coming weeks will be closely scrutinized. Early signs from companies like FedEx and Nike, which have reported weaker demand, suggest that the broader market rally may face challenges ahead.
