Wall Street is shifting its focus from the Federal Reserve’s interest rate pause to the critical arena of tech earnings and the burgeoning AI sector. Following a muted reaction to the Fed’s decision, the market is now prioritizing company fundamentals, with tech giants like Microsoft and Alphabet releasing their latest financial results.
Despite potential headwinds from higher yields and oil prices, indicators suggest a market recovery. Tech stocks, particularly in the neocloud and semiconductor spaces, are showing renewed strength, bolstered by strong corporate earnings and the upcoming public offering of AI firm Anthropic.
Wall Street is looking past the Federal Reserve's decision to pause interest rates, with the market's attention now firmly fixed on upcoming tech earnings and a potential rebound in Artificial Intelligence (AI) related stocks. The Federal Reserve's widely anticipated move to hold interest rates steady on Wednesday generated minimal market reaction, underscoring a shift in focus towards core business fundamentals.
Instead of the Fed's pronouncements, key events influencing the market were the latest earnings reports from tech giants like Microsoft and Alphabet, alongside Oracle's more conservative capital expenditure outlook. The muted reaction to the Fed's decision is seen as a positive sign, indicating that the market has already priced in the central bank's actions and Chairman Kevin Warsh's stance against forward guidance in non-crisis situations.
The market is now recalibrating based on third-quarter earnings and the trajectory of the AI sector. A recent bout of volatility, triggered by rising spreads on neocloud debt, appears to be subsiding, allowing investors to regain confidence.
Art Hogan, chief market strategist at B. Riley Wealth, noted the significant concentration of earnings reports, with a substantial portion of the S&P 500's constituents and market capitalization reporting in a single week. "The market is focusing on earnings, and thus far the scorecard looks very good," Hogan stated.
Tech stocks are showing signs of recovery, with neoclouds, in particular, experiencing a surge of over 16% this week, as evidenced by the performance of the Roundhill Neocloud ETF. The iShares Semiconductor ETF has also climbed more than 7%. This revival follows a record quarterly profit announcement from South Korean memory giant SK Hynix and Anthropic's filing of its S-1 registration statement for an upcoming public offering.
Investors are navigating a packed earnings calendar, with 163 S&P 500 companies scheduled to release their results. Early reports from Alphabet and Microsoft presented a mixed picture, with Microsoft's performance being favorably received, while Alphabet saw a post-hours dip due to projections of increased capital expenditures in 2027. Amazon.com is the next major player set to report earnings.
While companies are beating earnings forecasts at a respectable rate, there are signs of a slowdown. The S&P 500 is on track for its fourth consecutive quarter of above-25% earnings growth. However, revenue beats are averaging only 1.7% above consensus forecasts, a decrease from the 3.8% average in the second quarter, according to economist and strategist Ed Yardeni. Earnings have surpassed estimates by 6.5%, down from over 8% in the first and second quarters, which had benefited from exclusions of mark-to-market gains and tax reversals.
A silver lining is the ongoing improvement in profit margins, both within the tech sector and across other industries. As of October 23, the S&P 500's forward profit margin forecast reached a record high of 16.8%, an increase of 1.4 percentage points year-to-date. This positive trend extends beyond the 'Magnificent 7' group, with the S&P 493 companies collectively seeing their forward profit margin rise by an impressive 2.6 percentage points to 14.6% this year, Yardeni highlighted.
However, potential headwinds remain, including elevated yields and rising oil prices. The path for interest rates is expected to stay higher, with fed funds futures pricing in a quarter-point hike at the December Federal Reserve meeting, pushing the range to 4.00%-4.25%. Geopolitical tensions, particularly the ongoing conflict involving Iran, pose a risk of soaring oil prices and derailing market rallies, especially following the mid-term elections.
The outcome of the upcoming political elections also carries significant market implications. A sweep by Democrats in both the House and Senate would likely have a more pronounced market impact than a split Congress where Republicans maintain control of the Senate.
Despite a recent rebound in AI stocks, some investors are advocating for diversification away from the tech-heavy S&P 500. The Invesco S&P 500 Equal Weight ETF, for instance, has gained over 13% this year, reflecting the success of this strategy.
Jeffrey Gundlach, CEO-CIO of DoubleLine Capital, expressed a preference for a 30% equity allocation focused on the equal-weight S&P 500, stating, "I don't like the cap-weighted S&P. I don't want all this exposure to the epicenter of the blast radius of the AI problems or developing problems."
Conversely, some strategists remain bullish on equities broadly and see value in fixed income amid elevated yields. Ulrike Hoffmann-Burchardi, global head of equities at UBS Chief Investment Office, noted that despite potential future Fed hikes, the current backdrop remains favorable. "We do not believe a measured tightening cycle will derail the U.S. economy, and investors should maintain diversified equity exposure and use the rise in yields to add selectively to quality bonds," she advised.
