Third quarter starts with earnings trends largely intact, but nascent signs of trouble in tech land

The third quarter starts on Monday with corporate earnings trends largely intact, but showing early signs of trouble in tech land. The S & P 500 will end the second quarter up about 4%. The good news: for the big-cap tech companies that are truly dominating the market ( Apple , Microsoft , Alphabet , Nvidia , etc.) earnings trends are continuing to rise. The bad news: for those same dominant tech companies, the rate of change of the earnings is slowing down, and that may mean trouble for investors still piling into Nvidia, Microsoft, and Alphabet. Rate of change is critical Stocks are securities that offer ownership in the company and a claim on the company's assets and future earnings. Following the trend of earnings (up or down?) is therefore the most widely followed game on Wall Street, and it is not just whether earnings are rising, it's whether growth rates are accelerating or decelerating. If earnings for XYZ stock were rising 5% in 2022, then rising 10% in 2023, and are expected to rise 15% in 2023, that is good because: 1) earnings are going up, and 2) the rate of change of the earnings is increasing. That is what you are looking for. Big tech companies like Amazon, Meta, Microsoft and Nvidia have earnings estimates that are still going up in 2024, but the rate of change is slowing. That's not surprising: no one sees their earnings or cash flow rate of change increase every year into infinity. Take Nvidia. A little over a year ago, analysts caught on to the AI story and started dramatically raising future earnings estimates for Jensen Huang's company. Look at the rate of change in Nvidia's reported earnings during this time: Nvidia: reported earnings (with rate of change from prior quarter) July 2023: $0.27 +145% October 2023: $0.40 + 50% January 2024: $0.52 + 30% April 2024: $0.61 + 17% July 2024 (est.) $0.64 + 5% You see how the rate of change of the reported earnings went from 145% in July 2023 to just 5% for the upcoming (July 2024) quarter. That is a red flag, and many strategists, all of whom are grounded in fundamental analysis like earnings trends, have been sounding the alarm on this. "This tells me that Nvidia is slowly losing its positive earnings revision momentum, even though investors keep bidding up the price," Nick Raich from Earnings Scout told me. "Nvidia's stock is at risk, because if it merely maintains guidance, it's not going to be good enough anymore." Raich has a ranking system that measures the rate of change of earnings estimates. Nvidia has one of the worst scores, and most of the other major tech stocks have low scores as well. Lori Calvasina, Head of U.S. Equity Strategy at RBC Capital Markets, agrees. "We've got a trade that is generally full in terms of valuations," she told CNBC Thursday. "There are some things I've learned in my two decades on Wall Street. When you've got expensive valuations and decelerating growth rates from astronomical valuations, there is not a lot of margin for error." What about the rest of the market, the other 493 or so stocks in the S & P 500 that are not big cap tech? "The other companies have better earnings estimate revision trends, and their prices are cheaper," Raich told me. "They offer more compelling values." Cautionary forecasts from early reporters Outside of tech, there are some indications that second half estimates might be too bullish. Eighteen companies have reported earnings so far, and Nike , Walgreens , Micron , Levi Strauss , FedEx and General Mills were among the companies that gave outlooks that failed to impress Wall Street. Companies like Southwest Airlines and pool supply distributor Pool Corp. unexpectedly warned of weak results ahead too. One other warning sign: consumer-facing companies are already warning about significant pushback on price hikes. That hurt Walgreens profit margins after it resorted to "higher promotional activity" to stimulate sales in a challenging consumer environment. CEO Tim Wentworth told CNBC, "The consumer is absolutely stunned by the absolute prices of things, and the fact that some of them may not be inflating doesn't actually change their resistance to the current pricing." Promotional activity also weighed on margins for retailers like Macy's , Lowe's and Urban Outfitters , which all recently reported lower profit margins than a year ago. Nike told analysts that it "missed our fourth quarter plan on softer traffic, higher promotions [and] lower sales of certain classic footwear franchises." This week, McDonald's and Yum Brands' Taco Bell were the latest fast food players to launch value menus to help lure back more cash-strapped customers. The restaurant business has become increasingly competitive as consumers have sought out more value to combat soaring menu prices. General Mills also cautioned that pricing issues – not volume troubles – will be a headwind in the year ahead. Still no recession, in the economy or in earnings So far, we have a deceleration in big-cap tech earnings and clear signs the consumer wants lower prices. Regardless: this is not leading to a collapse in earnings. Overall earnings trends for the S & P 500 have been steady for months. Estimates for the current quarter and out to the end of the year are almost unchanged from the prior quarter, indicating (again) little expectation of an imminent recession. S & P 500: quarterly year-over-year earnings trends Q2: up 10.7% (trending higher) Q3: up 8.6% (flat) Q4: up 15.0% (trending higher) Source: FactSet Halfway through the year, 2024 is looking like it could easily achieve a double-digit rate of earnings growth, an impressive rebound after the subpar gains of 2023. And 2025 estimates are strong as well. S & P 500 earnings (YOY) 2023: up 3.9% 2024: up 10.7% 2025: up 14.2% Source: S & P Global The rest of the market for earnings: meh The double-digit earnings increases are largely due to big-cap tech. Earnings trends for tech may still be rising (even if it is decelerating), but the rest of the market is generally flattish on earnings. 2024 earnings trends Technology: rising trend Communication Services: rising trend Industrials: lower trend Consumer Staples lower trend Health Care lower trend Financials rising in Q4 You can see it in this chart, where the influence of the Magnificent 7 has had an outsized influence on the S & P 500, which is now waning: Source: LSEG Bottom line: tricky market July is generally one of the stronger months of the year, but this is a very tricky environment, with a complicated "stew" for investors to make sense of. Earnings: rising Positive Tech earnings: rising but decelerating Negative Job growth: strong but moderating Positive Interest rates: moderating Positive Inflation: moderating Positive Consumer: increasingly cautious Negative