U.S. stocks are extending their biggest two-day decline of the year heading into a key stretch of corporate earnings reports and inflation data next week that could define market direction over the traditional August lull.
Comments from Presidential frontrunner Donald Trump that suggest an overhaul of U.S. policy on Taiwan, the epicenter of the global tech supply chain, as well as reports suggesting President Joe Biden will tighten export restrictions on high-end chips to China trigged a massive sector selloff and the biggest decline of the year for the Nasdaq earlier this week.
However, with a year-to-date gain of more than 21% for the tech-focused benchmark, and an S&P 500 that was trading at the widest margin to its 200-day moving average since the spring of 2021, markets were primed for a pullback heading into what Goldman Sachs tactical strategist Scott Rubner has described as an historical turning point for market rallies.
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July 17, Rubner argued in a recent note, “typically marks the end of summer BBQ/pool/pirate-themed party for the S&P 500 since 1928”, adding that gains will be more difficult to come by during what is usually “worst month of the year for equity flows".
Mag 7 earnings on deck
That likely puts next week's earnings slate in stark focus, particularly with updates from Magnificent 7 peers Tesla (TSLA) , Google parent Alphabet (GOOGL) and online retail giant Amazon (AMZN) expected over the five-day stretch.
LSEG data suggests collective second quarter earnings for the S&P 500 are likely to rise 9.6% from last year to $489.9 billion, with around a third of that tally coming from the tech sector.
"Q2 is likely to be the beginning of a process that sees the earnings dominance of the Magnificent 7 give way to broader fundamental improvement," said Jason Pride, chief of investment strategy & research Glenmede.
Related: Investors reset bets for stocks, bonds after Trump shooting
"Broadening earnings growth is likely to reward diversification away from the preceding leaders, especially if valuations remain more compelling in other areas of the market," he added.
Google and Amazon, and to a lesser extent Tesla, will also be under pressure to articulate their AI-focused spending plans heading into the back half of the year as investors question that stretched valuations of chipmakers such as Nvidia (NVDA) , Advanced Micro Devices (AMD) and Micron Technology (MU) .
Bank of America's July Global Fund Managers' Survey, a closely-tracked benchmark, noted that investors continue to see the "long magnificent 7" trade as the most-crowded "by a country mile" on Wall Street and are starting to shift allocations to defensive sectors such as utilities.
Fed rate cut focus
The survey also indicated that investors are looking for at least three Federal Reserve rate cuts over the next twelve months, with the first coming at the central bank's September policy meeting in Washington.
That's likely to give markets an early autumn boost, but much will depend on the strength of the domestic economy, and its ability to avoid recession risks, heading into the final months of the year.
A stronger-than-expected reading for June retail sales, as well as a resilient labor market and surprisingly solid manufacturing activity data, continues to support growth readings, with the Atlanta Fed's GDPNow forecasting tool indicating a healthy current-quarter advance of 2.7%.
Related: CPI inflation report fuels Fed interest rate cut bets
Softer inflation readings, as well, are driving both September Fed rate cut bets as well as an impressive rotation into small-cap stocks, which has lifted the Russel 2000 index more than 10.4% over the past month.
However, LPL Financial's chief technical strategist, Adam Turnquist, isn't sure that this kind of trend will continue into the summer months and beyond.
"The jubilee of the recent small cap rally should be tempered as we expect to find signs of a weakening economy in the latter half of 2024," he said. Strong consumer spending has staved off the hard-landing narrative (but) the labor market has also shown signs of cooling as initial jobless claims have been ticking higher since the start of the year."
"Despite attractive valuations, improving technicals, and potential rate cuts, a slowdown in economic growth and a softening labor market could make the bull case for small caps much more opaque," he added.
Political risks rising
Political risks are also starting to pile up, as evidenced by last week's attempted assassination of former President Donald Trump and the ongoing pressure for President Joe Biden to stand aside following his disastrous debate performance last month.
The BofA Fund Managers' Survey, in fact, showed that political risks have overtaken inflation worries and the number one market concern, although nearly half of those polled said stocks are still likely to rise in the event of one party "sweeping" the U.S. elections in November.
More Economic Analysis:
- June jobs report bolsters bets on an autumn Fed interest rate cut
- Biden debate flop boosts Trump, but economy may be tougher opponent
- First-half market gains come with a dash of investor unease
All of this does leave stocks vulnerable for a pullback heading into the August lull, although Apple's (AAPL) fourth-quarter earnings on Aug. 1, as well as Fed Chairman Jerome Powell's Jackson Hole address on Aug. 22 and Nvidia's second-quarter update on Aug. 23, will very likely punctuate the traditional summer lethargy.
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