A handful of large growth and technology names that have dominated the US stock market in 2023 are set to report earnings in coming weeks, potentially determining the path for this year’s equity rally.
Lately dubbed the “Magnificent Seven” by investors, shares of the US companies with the biggest market values soared between 40 per cent and more than 200 per cent so far this year.
Those moves have accounted for a lion's share of the S&P 500's 17 per cent year-to-date rise and propelled the index to its highest level since April 2022.
The outsized gains have come with big earnings expectations for the seven companies: Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms.
BofA Global Research projects they will increase earnings by an average of 19 per cent over the next 12 months, more than the double 8 per cent estimated rise for the rest of the S&P 500.
They will need strong results to justify premium valuations. Those companies trade at an overall trailing price-to-earnings ratio of about 40 times, versus 15 times for the S&P 500 excluding those companies, according to BofA.
Their results may be crucial to the market as a whole. Fuelled by their recent gains, megacap stocks have climbed to dominate benchmark indexes, causing headaches for some managers of active funds.
In the S&P 500, the seven stocks comprise 27.9 per cent of the index's weight.
Investors will look beyond second quarter results, said Bill Callahan, an investment strategist at Schroders.
“It’s also how do these big companies, which are carrying the market ... guide for the rest of the year and into 2024,” he said.
Overall, the seven companies account for 14.3 per cent of overall S&P 500 estimated earnings for the second quarter, and 9.3 per cent of estimated revenue, according to Tajinder Dhillon, senior research analyst at Refinitiv.
Among the reports in the previous quarter, Nvidia was one of the standouts. The semiconductor company's revenue forecast blew past estimates as it said it was boosting supply to meet surging demand for its artificial intelligence chips, further fanning the market's excitement over AI. Nvidia shares are up well over 200 per cent this year.
Tesla is the first of the growth companies to report, with earnings expected on Wednesday. The Elon Musk-led company this month said it delivered a record number of vehicles in the second quarter.
Microsoft and Meta are among the companies due to report the following week, and investors are expected to focus on how companies are seeking to harness AI.
While AI benefits may not immediately materialise for every company, investors are eager to learn "more about how they are going to convert that into money, essentially", said Thomas Martin, senior portfolio manager at Global Investments.
"It’s going to take some time for that to work its way through and to show up," said Mr Martin, who is overweight some of the megacap stocks.
"Along the way, people are going to want to see some sort of progress."
There are signs market gains are broadening beyond the megacaps. The equal-weight S&P 500, a proxy for the average stock, is modestly beating the S&P 500 over the past month – up 3.6 per cent versus about 3 per cent for its counterpart. The equal-weight version trailed badly for most of 2023.
Strong US data have driven confidence the economy can avoid a long-feared recession. A so-called "soft-landing" could lift cyclical stocks such as industrials and small-caps that are trading at cheaper valuations.
But many investors say the corporate giants are nevertheless here to stay as critical holdings.
Yung-Yu Ma, chief investment officer at BMO Wealth Management, said that while “there is a lot priced in” to megacaps’ valuations, that did not mean they are overvalued.
"If you think about the megacaps broadly ... they have gone from a core holding of a portfolio to an almost absolute necessary major component of the portfolio once you factor in trends such as AI," he said.
