The U.S. stock market is currently experiencing a significant capital rotation, with funds flowing away from the technology giants that have led the market over the past three years and moving towards banks, consumer goods, and materials producers. Investors are betting that these traditional sectors will benefit from the anticipated acceleration of U.S. economic growth in 2026. However, this rotation strategy is now facing a reality check with the onset of earnings season. As the fourth-quarter earnings season commences, large-cap technology companies are still expected to be the primary engine for the overall profit growth of the S&P 500 index. According to data from Bank of America, the technology sector is projected to achieve a 20% year-over-year earnings growth, whereas the growth rate for non-technology sectors could decelerate sharply from 9% to just 1%. Piper Sandler's Chief Investment Strategist, Michael Kantrowitz, stated:
"Earnings guidance will be a critical signal. This is the first time we are entering a year with broad-based stimulus tailwinds, which is crucial for creating sustainable profit expansion."
Technology stocks continue to dominate profit growth. Despite recent signs of market funds rotating from technology stocks to value stocks, earnings forecasts from multiple institutions indicate that tech stocks will still command an absolute dominance in profit growth over the coming year. A team led by Bloomberg Intelligence analyst Wendy Soong projects that the profit growth rate for a portfolio of S&P 500 value stocks is approximately 9%, a figure that is only one-third of the expected growth rate for growth stocks. As the core component of the growth stock index, the technology sector's profit growth is anticipated to be as high as 30%. Despite the significant growth gap, traditional economic sectors are not without their highlights. Data from Bloomberg Intelligence shows that industrial companies' profits are expected to grow by 13%, while the growth rate for non-essential consumer goods and services companies is forecast at 12%. Furthermore, defensive sectors such as healthcare, materials, and consumer staples are also expected to see growth rates nearing 10%. This indicates that while tech giants lead the growth, some traditional industries can still provide stable earnings support. The rotation trade faces a test of high expectations. Following years of market dominance by technology stocks, the current scale of rotation into traditional sectors is now too significant to ignore. The Federal Reserve's entry into an interest rate-cutting cycle has opened a new window of opportunity for economically sensitive industries. Simultaneously, traders are growing skeptical about whether the artificial intelligence theme can continue to support sky-high valuations. These factors are collectively prompting fund managers to withdraw from long-time leading tech giants and seek more diversified allocations. Data from Deutsche Bank confirms that this trend is accelerating. Overall holdings in large-cap growth and technology stocks continue to decline, while exposure to small-cap stocks has climbed to its highest level in nearly a year. From a sectoral fund flow perspective, funds specifically investing in the technology sector saw nearly $900 million in net outflows last week, whereas other sectors attracted $8.3 billion in net inflows, with materials, healthcare, and industrial sectors performing most prominently. Matt Maley, Chief Market Strategist at Miller Tabak + Co., pointed out:
“This earnings season is critical for the other 493 companies in the S&P 500, excluding the 'Magnificent Seven' tech giants, as well as for small-cap stocks. Market expectations have been pushed higher, consequently setting a very high bar for performance.”
He added that although institutional investors remain overall overweight on tech stocks after some reduction, they are actively searching for the next destination for their "rotation." Therefore, even if corporate earnings merely meet expectations, it could trigger more pronounced internal capital rotation within the stock market. Policy stimulus provides support. Piper Sandler's Chief Investment Strategist, Kantrowitz, explicitly stated that he is currently most optimistic about cyclical sectors such as transportation, housing-related industries, and manufacturing. He noted:
"The Fed's accommodative policy, falling oil prices, and easing lending standards are creating potential tailwinds for the weaker, lower part of the 'K-shaped' economy."
This policy mix is seen as a key driver supporting the earnings recovery in non-technology sectors. Investors are betting that, under the combined effect of these favorable factors, the U.S. economy could achieve accelerated growth in the first half or even the entirety of 2026, thereby propelling the performance of traditional cyclical sectors to surpass that of highly-valued tech stocks. However, the sustainability of this market rotation urgently requires validation from fundamentals. Companies must provide robust earnings guidance to justify the outflow of funds from technology stocks. In recent years, market gains have been primarily supported by a handful of AI-related giants; now, the market needs to see broader and more solid profit growth to support overall valuations and extend the current rotation trend.
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