Equities should find support with earnings in full swing

Microsoft’s cloud business reported a 29% year-over-year revenue gain for the second quarter on Tuesday after the US market close, decelerating from the 31% y/y growth in the previous three months. The tech giant, however, said it expects cloud growth to accelerate in the first half of next year. While the slight revenue miss sent its shares down as much as 7% in extended trading, they have since recovered to a decline of 2.5%. Nasdaq futures for Wednesday’s session are up 1.4% at the time of writing, after the index fell 1.3% on Tuesday.

Megacap earnings are poised to shape market sentiment in the coming days, with companies including Meta, Apple, and Amazon set to report quarterly results. A Federal Reserve meeting that could open the door to the first interest rate cut since the pandemic is also high on investors’ agendas. Elsewhere, the Bank of Japan on Wednesday raised rates to 0.25%, from 0-0.1%, and unveiled a detailed quantitative tightening plan. The Bank of England could begin cutting rates on Thursday.

Without taking single-name views, Microsoft also reported an uptick in artificial intelligence (AI) adoption, and guided for another 28-29% in growth for the September quarter. The fall in operating margins forecast by Microsoft over the next 12 months is smaller than what the market had expected.

With the earnings season in full swing, we believe profits for S&P 500 companies remain on track to grow 10-12% for the second quarter. The combination of resilient US economic growth, falling inflation, likely Fed rate cuts, and solid AI spending should push up the benchmark to 5,900 by the end of the year, in our view.

The tech sector should see 20-25% earnings growth. More details are still due in the coming days, but we maintain our positive outlook on the technology sector amid strong AI capex and demand. Microsoft’s guidance suggests monetization is picking up gradually amid solid growth, and AMD raised its 2024 AI chip sales guidance on strong demand and tight supplies through 2025. Our latest supply-chain checks also suggest strong demand for AI accelerators, which include both GPUs and custom chips. Following the recent tech correction, we see tactical opportunities in companies with strong earnings growth visibility. We continue to like AI beneficiaries in the semiconductor, software, and internet sectors.

Overall, earnings reports have been positive across sectors. Companies accounting for more than 50% of the S&P 500 market capitalization have now reported, and the results have been generally positive overall. So far, some 60% of companies beat sales estimates and 75% beat earnings estimates, in line with historical averages. Guidance for the third quarter is also in line with normal seasonal patterns. While it appears that lower-end consumer spending weakened a bit further in the second quarter, as highlighted by Visa, Coca-Cola, and McDonald’s, banking services provider Capital One flagged a resilient labor market, with US consumers remaining a source of strength in the US economy. Additionally, companies continue to suggest inflation and pricing pressures are easing.

Positioning and rotation impact are likely to fade. Equity market volatility has picked up, although second-quarter results have been mostly in line. For example, Alphabet’s earnings beat estimates by 3% and analysts have raised their forecasts for 2024 and 2025. However, its shares fell 6% on the week. Conversely, chemical company Dow was only down 2% last week despite missing earnings estimates by 6%, which prompted analysts to cut full-year 2024 and 2025 estimates by 6-7%. We believe this reaction is related to investor positioning and the high bar for tech companies heading into earnings—Alphabet shares had risen 27% this year through last week, while Dow's shares were flat on the year. However, we think investors are likely to shift their focus back to fundamentals, with technical factors supporting the rotation likely to dissipate soon.

So, again without taking a single-name view, we continue to see a favorable backdrop for US equities and advise investors to maintain a full allocation to the US market. We believe AI beneficiaries should continue to account for a substantial part of portfolios as the technology drives further growth in the years ahead, but we also see opportunities in other quality companies, including those exposed to secular trends like the energy transition, blue economy, and water scarcity.