The next catalyst for a market looking to broaden out could be in corporate earnings. The second-quarter earnings season is ramping up in the week ahead at a strange moment for markets. On Thursday, the S & P 500 and Nasdaq Composite tumbled after softer inflation data spurred investors to take profits in the mega-cap tech names, even as internal breadth posted a drastic improvement. Market darling Nvidia dropped in one of its worst days of the year, while interest-rate sensitive groups such as small and mid caps outperformed. In fact, Thursday’s 2.2% drop in the top 10 S & P 500 stocks, and the jump in the balance of the broad-based market, of 1.3%, is the fourth largest rotation to small from large in the past two decades, according to Patrick Palfrey, strategist at UBS. IWM 5D mountain iShares Russell 2000 ETF Next week’s earnings results will help investors glean whether that rotation trade is sustainable. Investors are deliberating whether they can continue to count on the artificial intelligence trade that has carried the S & P 500 to all-time highs, or if they should start broadening out their exposure from here. “[Thursday] was certainly a rotation day, where the leaders got pulled down, and the laggards really finally kind of bid this year,” said Art Hogan, chief market strategist at B. Riley Financial. “I think the earnings season may be the next catalyst for that type of move.” On Friday, at least, it seemed as though the rotation trade was intact. The Dow Jones Industrial Average, which is weighted more toward the real economy than the S & P 500 and Nasdaq, touched a new record above 40,000 during the session. The rotation trade Many investors expect Big Tech could underperform from here, given their high valuations, and even higher expectations heading into earnings season. According to FactSet consensus estimates, S & P 500 companies are set to post blended earnings growth of 9.2% in the second quarter. Keith Buchanan, senior portfolio manager at Globalt Investments, said he’s cautious on the mega-cap names, noting that he’s moving to a neutral stance on the group. While he’s optimistic about the long-term growth prospects for AI, he anticipates some near-term challenges for the companies. “We could have a situation where earnings could you know, 70% of companies could beat earnings, which is a very high clip from a historical standpoint, but 10 or even three or four of the top can meet the number and don’t beat, or beat and raise, [and] there’s a very high likelihood the market would take that as a disappointing season and trade lower,” Buchanan said. “So, I think the dislocations between the top 10 and the other 490 [in the] S & P 500 really distorts the takeaways that you can have on an aggregate level,” he added. B. Riley Securities’ Hogan said he still anticipates the S & P 500 could end the year even higher than his original forecast of 5,600, as he expects strong earnings and lower interest rates. “It’s not unthinkable to see us exiting this year at 5,800 on the S & P,” he said. But he, too, expects investors should trim exposure to the mega caps and allocate them to other underperforming parts of the market. Historically speaking, at least, the pivot into small caps, and away from Big Tech, could continue for some time, according to UBS. Strategist Palfrey noted that the trend can continue for four weeks following a “significant” one-day rotation, meaning that now is the time for investors to become active stock pickers. “Given large cap managers’ propensity to underweight the biggest stocks, [Thursday] proved to be one of the best days for mutual fund alpha generation in the past two decades. This follows a difficult 2Q, when 75% of Large Cap Core managers trailed the S & P 500,” Palfrey wrote. “Further underperformance of mega caps should prove beneficial for alpha generation.” Read-throughs On the calendar, investors will get further read-throughs on the consumer, such as with the June U.S. retail sales data that is anticipated to come in weaker than in the prior month, according to FactSet consensus estimates. Wall Street will use the data to get a read on the economy. David Sekera, Morningstar’s chief U.S. market strategist, said that a weaker-than-expected number could be an indication that “the economy is slowing more than what we currently have modeled into our base case.” Quincy Krosby, chief global strategist at LPL Financial, said the retail sales data could show whether the recent small-cap outperformance is “warranted,” as the group is more sensitive to changes in the economy. Elsewhere, there are earnings results from the remaining major banks. Goldman Sachs and BlackRock are set to report on Monday, with Morgan Stanley and Bank of America due to report results on Tuesday. AI bellwethers ASML and Taiwan Semiconductor are also due out with results, on Wednesday and Thursday, respectively. Week ahead calendar All times ET Monday, July 15 8:30 a.m. Empire State Index (July) Earnings: Goldman Sachs , BlackRock Tuesday, July 16 8:30 a.m. Export Price Index (June) 8:30 a.m. Import Price Index (June) 8:30 a.m. Retail Sales (June) 10 a.m. Business Inventories (May) 10 a.m. NAHB Housing Market Index (July) Earnings: J.B. Hunt Transport Services , State Street , Morgan Stanley , Bank of America , PNC Financial Services Group , UnitedHealth Group Wednesday, July 17 8:30 a.m. Building Permits (Preliminary) 8:30 a.m. Housing Starts 9:15 a.m. Industrial Production 9:15 a.m. Manufacturing Production 2 p.m. Fed Beige Book Earnings: United Airlines , Discover Financial Services , U.S. Bancorp , Johnson & Johnson , Citizens Financial Group , ASML Thursday, July 18 8:30 a.m. Continuing Jobless Claims (07/06) 8:30 a.m. Initial Claims (07/13) 8:30 a.m. Philadelphia Fed Index (July) 10 a.m. Leading Indicators (June) Earnings: Netflix , M & T Bank , KeyCorp , Domino’s Pizza , D.R. Horton , Blackstone , Taiwan Semiconductor Friday, July 19 Earnings: SLB , American Express, Halliburton , Fifth Third Bancorp , Regions Financial , Huntington Bancshares
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