Big tech is driving the S&P rally. The rest have to step up soon

“To have a similar return for the market in the second half, you’d need to see broader participation,” said Keith Lerner, co-chief investment officer and chief market strategist at .

That looks like it may happen. While Big Tech’s is expected to slow dramatically from here, industries like materials and are expected to see roughly 25% profit growth by the fourth quarter after posting contractions of 20% or more in the first quarter.

Bloomberg

“I think those are starting to look pretty interesting, and I’m talking about energy, materials, consumer discretionary, industrials, ,” said Ohsung Kwon, equity and quantitative strategist at . “I think all those cyclical sectors are going to do better in the second half of the year.”

That rotation already appears to be underway. At , clients pulled almost $2.2 billion from during the week ended May 31, the second-most in the bank’s data going back to 2008. The biggest client inflows went to the consumer discretionary sector, which is up 1.9% this year, making it the second worst performer in the S&P 500.

“Discretionary is traditionally a huge driver of S&P 500 earnings and a place that typically picks up the slack,” said Michael Casper, equity strategist at Bloomberg Intelligence.

Can’t Quit Tech

None of this is to say investors will, or should, give up on Big Tech. The S&P 500 is up 12% this year, and its five biggest stocks — , , , Alphabet Inc. and Amazon.com Inc. — are responsible for more than half of that gain with markets captivated by the artificial intelligence boom.

In the process, those five companies have added a combined $2.9 trillion in market value in 2024. That’s helped make information technology by far the biggest sector in the S&P 500, with a 31% weighting. The next closest groups are financials and health care at around 12%.

What’s more, it’s not like are done growing. It’s just that the pace of their profit expansion is slowing. After three consecutive quarters of more than 44% earnings growth, the S&P’s five biggest companies are expected to see that figure fall to 29% in the second quarter before settling into the teens in the second half of the year, according to data compiled by BI.

“We still think Big Tech will likely outperform, but at a more moderate level,” Lerner said. “Investors will continue to stick with these companies, which are high quality, have strong cash flow, a lot of cash on the balance sheet.”

In many ways, the companies are suffering from their past success, as their strong 2023 results make for challenging comparisons to 2024. But the businesses are still increasing profits and generating healthy margins after aggressive cost-cutting efforts.

‘Lofty Expectations’

“The onus is on Big Tech to live up to lofty expectations,” said Adam Sarhan, founder of 50 Park Investments. “Or else the stock market will be forced to recalibrate and sell off, particularly if profit growth from other sectors doesn’t improve from here.”

Part of the challenge for tech investors is the stocks are already quite expensive. Nvidia is priced at 40 times profits projected over the next 12 months, compared with 21 times for the S&P 500. Microsoft is at 33 times, and Apple is at 29 times. Even Alphabet, which is relatively cheaper at 21 times, is trading above its average over the past 10 years.

Bloomberg

“As those non-tech sectors start to grow earnings, the premium that investors were paying for tech should come down on a relative basis compared to other sectors,” BofA’s Kwon said.

There’s also an emerging asymmetry in the directions of Big Tech stocks as the companies’ earnings outlooks diverge.

With investors focused on AI, Nvidia has soared ahead of the pack, climbing 144% this year and continuing as the best performer in the S&P 500. Facebook-parent Meta Platforms has added 39%, while Google-parent Alphabet has climbed 25% and Amazon has gained 21%. Microsoft, on the other hand, hasn’t really kept up, posting a relatively meager 13% rise. And then there’s struggling Apple, which spent most of the year in the red and is up just 2.3% in 2024.

“The fundamental business lines of each of these companies aren’t moving in the same direction anymore like during the recovery from the pandemic, so that’s also causing a profit cool down,” BI’s Casper said. “The Magnificent Seven stocks no longer move as one ubiquitous block, and that hurts its earnings potential as a cohort because the trade has now broken up.”

Picking Sectors

Counting on a lift from the rest of the market carries its own risks, however. For example, health care margins are shaky despite the enthusiasm for anti-obesity drugs because the group is still grappling with charges from big drug companies. Meanwhile, the consumer discretionary sector’s earnings growth is being driven by just a handful of companies, like Amazon and home-improvement retailer Home Depot Inc.

That means more sectors beyond those will need to post profit growth, particularly consumer discretionary and those closely tied to the health of the economy: industrials and financials, Casper said. However there are risks embedded in each of these groups.

“Consensus earnings forecasts are pretty poor for most retailers not named Amazon,” he said. “Financials and industrials may pick up their pace, though regional banks still face a hangover from (the collapse of Silicon Valley Bank).”

In the end, the stock market’s success in 2024 still may come down to Big Tech, directly or indirectly. With AI expected to have a transformational impact on so many industries, technological development will likely spill over into other parts of the economy, lifting those shares along the way.

“As long as Big Tech companies continue to deliver on their profit outlooks, that bodes well for the economy,” 50 Park’s Sarhan said. “Which will help power the stock rally further because there are other industries outside of technology that will benefit from AI.”