Picking up where we left off, the US reporting season underway has started to yield insights on Q2 performance for the economy. The previous week, the much-anticipated big banks (Bank of America, JP Morgan Chase and Citigroup) all beat their earnings expectations, albeit by relatively small margins. In the absence of credit stress, the soft-landing thesis remains intact for now. Last week, their results were confirmed by an array of large caps across various sectors that all reported small beats (Johnson & Johnson, Pepsico, Fedex, United Airlines). A notable exception came from the Energy sectors, where sales (rather than earnings) disappointed to the downside.

By contrast, the first few insurance companies to report beat their estimates by wide margins, indicating that insurers continue to increase premiums with no impact on sales. If you recall, Andrew Hunt raised this specific topic in our recent conversation as one reason (among others) for why inflation will be slower to come down.

The results of the Magnificent Seven are yet to come (Alphabet and Tesla this week, Meta, Microsoft, Apple and Amazon next week), but two results from last week could give us an indication of what’s to come. Semiconductor manufacturer Micron Technology beat its earnings expectation by 24%, Netflix did the same (by 3%) yet both saw their share price fall. Has too much tech earnings growth expectations been priced-in and are valuations beginning to reassert themselves? This would mean that despite a soft-landing economy, slowing inflation and rate cuts, we could still see share market weakness. 

To be fair, the share price drop in semiconductors was widespread and had more to do with fears of further US trade restrictions against China than with reporting season. Nevertheless, the fact that investors flocked to undervalued corners of the market, such as energy companies, financials, and real-estate firms is interesting. The rotation out of mega-cap tech stocks and into small-cap stocks and economically sensitive sectors raised some eyebrows. Is this the start of the much-awaited broadening of the market rally? 

We will continue to look for clues in the coming weeks. In the meantime, we note that analysts expect the "Magnificent Seven" (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla) to report a 28% jump in earnings for the second quarter, while profits from the other S&P 500 stocks are expected to slip 1%. In contrast, Russell 2000 companies are expected to report a nearly 18% rise in second-quarter profits, (snapping a five-quarter streak of year-over-year declines). The bar for small caps isn’t as low as in previous years, and the difference between results and expectations will drive short-term price action rather than actual results.

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