Markets hate uncertainty, but confusion is the real problem these days. Don't be surprised if the stock market faces further losses into the fall -- or at least until the disorientation begins to fade.
For years now, the market has followed a simple narrative: Artificial intelligence would be the next big thing, and stocks benefiting from AI would thrive, while shares of disrupted companies would get hit. That theme helped drive the S&P 500 to an annualized gain of 24% for the three years ended May 31, while the VanEck Semiconductor exchange-traded fund returned 61% annualized and the Invesco S&P 500 Equal Weight ETF rose just 16%. It also helped that the Federal Reserve was expected to lower interest rates, and the economy was expected to boom.
Now, the stock market is doubting everything it once held true, and it has the potential to end the years of easy returns. Rate hikes might be coming sooner rather than later; the economy might be on weaker ground than it looks; and all that spending on AI might be unsustainable. That's an awful lot of mights -- although much of the underlying data haven't changed -- but the doubts have caused chip stocks to drop 11% over the past two months, while out-of-favor sectors like healthcare, financials, and consumer staples are suddenly gaining. If you're confused, you're not the only one.
Heading into the teeth of the second-quarter earnings season, what's surprising is how little has changed. Collective S&P 500 earnings are expected to rise more than 27% during the second quarter from last year to just under $702 billion, according to LSEG data. While that's modestly slower than the nearly 30% advance recorded over the first three months of the year, it would deliver the best first-half profit performance, in terms of percentage gain, since 2020.
And so much still depends on tech. The three sectors containing the bulk of tech-company profits -- tech, communication services, and consumer discretionary -- should comprise around half of that $702 billion forecast, according to Barron's calculations, while Ben Snider at Goldman Sachs suggests a staggering 40% of S&P 500 earnings growth will come from just two stocks: Micron Technology and Nvidia. And if anything, expectations are rising. Overall earnings forecasts have risen by 3.4% since the end of March, the most since 2021.
That sets a massively high bar heading for the sector, one that it's struggling to clear. Google parent Alphabet topped Wall Street's earnings forecasts earlier this month, but boosted its AI spending plans to around $205 billion and reported its first negative free-cash-flow reading in more than two decades alongside it. The stock slumped more than 7% in response. "The usual cushion companies get from a de-risked estimate intraquarter doesn't exist," says Anthony Saglimbene, chief equity market strategist at Ameriprise.
For some, the pullback in tech isn't a reason to worry -- it's an expression of exhaustion, and nothing that a period of rest and relaxation can't cure. "We don't think the AI rally has run out of steam, despite the mixed performance of tech stocks," says Thomas Mathews, head of markets for the Asia-Pacific region at Capital Economics. "But one reason not to panic is that tech earnings -- which have driven the rally so far -- are showing little sign of wobbling."
The risks to the bull market, however, are piling up. The S&P 500 has dropped just 2.6%, but that decline was enough to cause it to breach its 50-day moving average, a key benchmark for near-term performance, in late July. Stocks rebounded the last time that happened in April, but the backdrop is trickier now. Inflation pressures, tied in part to the surge in crude oil prices from the U.S. war with Iran and price hikes due to rising chip prices, are likely to quicken over the coming months. The Fed, once thought to be leaning dovish, is now far more likely to hike rates.
Treasury yields have been on a slow upward march since early May. The yields on two-year notes -- those most closely linked with interest-rate forecasts -- have gained more than 45 basis points over the past 2 1/2 months and recently traded at 4.233%, the highest yield since January 2025. (A basis point is 1/100th of a percentage point.) Higher yields put pressure on stock valuations by offering a better "risk-free rate," making equities less attractive.
Political risks also loom. The period around the midterm elections has typically been tough for the U.S. stock market, according to Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, who notes the volatility around President Donald Trump's first term in 2018 and Joe Biden's in 2022. "While we see election risk as a temporary repricing, an issue we're monitoring is how sentiment around AI concerns may manifest in campaign season, which could have some spillover into stocks," she says.
Some signs are already pointing in that direction. The Cboe S&P 500 Dispersion Index, which tracks the difference between individual stocks and the Cboe Volatility Index, or VIX, is trading near the highest levels since the Covid pandemic, implying that equities are moving more of their own accord. While that can be good for stockpickers, it can also be an omen. "Periods of elevated dispersion in the past have sometimes been followed by steep selloffs, such as the dot-com bubble," says Hardika Singh, economic strategist at Fundstrat.
It doesn't have to play out that way. What seems to be happening in the tech space is something akin to a vibe shift in markets, where investors move from pricing in promise to pricing in execution, according to LPL Financial Chief Equity Strategist Jeff Buchbinder. As the shift takes hold, the benefits of that execution will get reflected in other sectors of the market, including industrials, financials, and healthcare. "Investors should focus less on who is spending the most and more on who is generating measurable returns," Buchbinder says.
Or they could wait for a pullback that seems almost inevitable at this point.
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