Stocks Power Ahead on Tech Rally

What You Need to Know

Stocks rebounded after their worst week since April as investors turned their focus to the start of the technology earnings season.
The S&P 500 rose 1.2%, and a gauge of the Magnificent Seven megacaps rallied 2.7%, led by gains in Tesla and Nvidia.
The recent outperformance of U.S. small caps, though, is facing technical resistance and a lack of momentum, says Morgan Stanley’s Mike Wilson.

Stocks rebounded after their worst week since April as investors looked beyond Joe Biden ending his reelection campaign to focus on the start of the tech earnings season.

The megacap space rallied, with the Nasdaq 100 up almost 2%. Despite the recent slump that had some on Wall Street bracing for a summer correction, respondents to Bloomberg’s Markets Live Pulse survey expect earnings to reinvigorate the S&P 500.

With results from Tesla Inc. and Alphabet Inc. on deck Tuesday, nearly two-thirds of the 463 respondents to the questionnaire expect corporate profits to boost US equities.

Sky-high valuations and seasonal weakness have incited some pullback warnings, with traders also facing political uncertainties. Yet the market reaction to Biden’s decision to quit the race and endorse Kamala Harris has so far been fairly muted, with the U.S. dollar and Treasuries seeing small moves.

“This political shake-up shouldn’t materially alter the direction of the markets,” said Tom Essaye at The Sevens Report. “The ultimate direction of the S&P 500 will still be determined by economic growth.”

The S&P 500 rose 1.2%. A gauge of the “Magnificent Seven” megacaps rallied 2.7%, led by gains in Tesla and Nvidia Corp. The Russell 2000 of small firms added 1%. CrowdStrike Holdings Inc. tumbled amid the continued fallout from a faulty software update.

Treasury yields edged higher, setting the stage for this week’s readings on the economy as well as the Federal Reserve’s preferred inflation gauge. The expectation of a rate cut in September had boosted shorter-term maturities — narrowing the gap with longer-dated bonds — for much of July.

“Don’t get us wrong, the upcoming election will certainly still be a focus for everybody — including investors — over the coming months, but there will be times when their focus will move to other issues, said Matt Maley at Miller Tabak + Co.

To Peter Boockvar at The Boock Report, debts and deficits are going to continue to skyrocket regardless of who wins the election.

“If Trump wins, we’ll get a full extension of the 2025 tax cuts but a possible slew of tariffs, more protectionism and likely a weaker dollar,” Boockvar said. “If Harris wins (assuming she’s the nominee), some of those Trump tax cuts will not be extended and we’ll get only some tariffs but still a lot of protectionism and possibly a weaker dollar.”

“I think up until the election, markets are going to trade more so on the trajectory of inflation, earnings, the economy and what the Fed does,” he concluded.

Since 1928, the S&P 500 has advanced roughly 5% on average in the third quarter of election years, logging positive returns nearly two-thirds of the time during the July through September period, according to data from Bloomberg Intelligence. Its track record has been even better in times a sitting president was up for reelection, averaging a nearly 8% rise in those months.

Strategists at BlackRock Investment Institute are reiterating their conviction in U.S. equities after the S&P 500 logged its worst week in three months.

“We see pullbacks as an opportunity to lean into stocks,” team led by Wei Li wrote. “Looking through near-term noise” of small-cap rally, big tech is likely to keep driving returns as companies carry positive earnings results for the market, the strategists said.

After driving the rally in U.S. stocks for most of the year, big tech slammed into a wall last week. Investors rotated from high-flying megacap shares to riskier, lagging parts of the market, spurred by bets on Fed rate cuts and the threat of more trade restrictions on chipmakers.

Outlook for Small Caps

Still, the recent outperformance of U.S. small caps is facing technical resistance and lacks fundamental drivers to carry on for a longer period of time, according to Morgan Stanley’s chief U.S. equity strategist Mike Wilson.

“While we’re respectful of still light sentiment/positioning in small caps, we see limited fundamental and macro justification for small cap outperformance continuing in a durable manner,” Wilson and his team said in a note to clients.

Prospects of a Republican win in November’s presidential election may invoke small-cap “animal spirits,” but that is likely to be short lived, according to Morgan Stanley’s Lisa Shalett. “We prefer the resilience of large caps to small caps — bottom line,” she wrote.

John Stoltzfus at Oppenheimer Asset Management saw last week’s market action as some prudent consideration by investors in addressing a need to redistribute the weighting of opportunity and risks across more than a few sectors, styles and market capitalizations.

“That said, we remain positive on technology stocks suggesting that investors “don’t change horses in the middle of a stream” but rather that they consider distributing the load of risk and opportunity across more than a few “horses” better known in equity investing as: companies, sectors, market capitalizations and styles, he noted.

The S&P 500 just exited what’s historically been its best two-week stretch of the year in the first half of July, and is approaching its most challenging stretch in August and September.

Profit estimates for the S&P 500 in the second quarter haven’t been cut as much as they normally have, according to JPMorgan Chase & Co. strategists, a sign that there’s little room for disappointment this earnings season. A team lead by Mislav Matejka said usually projections fall by 5% in the three months before results, but this time it’s been about 1%.

The “market is trading near highs, with full positioning and extreme concentration, suggesting that there is not much scope to absorb any disappointments,” they wrote.

“The heart of earnings season begins this week and plenty of tech companies report, which should give investors an idea of how healthy the overall economy looks through corporate eyes,” said Paul Nolte at Murphy & Sylvest Wealth Management.