The profit "dominance" of U.S. tech giants comes to an end? Earnings growth is spreading across the entire industry.

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As the US stock market’s fourth-quarter earnings season draws to a close, the longstanding situation where profits have been dominated by a few major tech giants is undergoing a fundamental shift.

Since mid-December last year, the Russell 1000 Value Index has significantly outperformed its growth index counterpart. Latest earnings show the number of sectors in the S&P 500 with positive growth has risen from six in the third quarter to eight (out of a total of eleven sectors), with nearly half of companies achieving double-digit growth rates and a median growth rate close to 10%, marking a four-year high.

Bankim Chadha of Deutsche Bank points out that growth has started to spread out beyond the mega-cap tech stocks. The overall earnings growth rate for the S&P 500 has risen slightly to a four-year high of 14.5%.

Bloomberg columnist John Authers analyzes that the market is undergoing a clear style rotation, which is not driven by a decline in tech giants, but rather by cyclical factors boosting earnings in other market sectors. The previously extremely rare era of profit concentration in the US stock market may be coming to an end.

Although the story of artificial intelligence (AI) still dominates, a cooling job market and cyclical tailwinds are reshaping investor expectations. The decline in US Treasury yields and changes in inflation data are providing the macro backdrop for this shift in capital from the “new economy” to the “old economy,” and this process shares many similarities with the style rotation between 2000 to 2003.

Value Returns and Cyclical Recovery

The core issue of market concentration lies in the imbalance of earnings growth.

Since the end of 2022, the ten largest companies in the S&P 500 have contributed about two-thirds of the index’s per-share earnings (EPS) growth, whereas during the internet bubble period, this ratio was only one quarter.

However, research models by Jeffrey Schulze and Josh Jamner of ClearBridge show that the US economy is currently in a phase of “robust broad-based expansion,” which usually benefits a wide range of corporate profits. The disclosed earnings of S&P 500 constituents have confirmed this trend.

Andrew Lapthorne of Societe Generale believes that, ironically, the AI boom may be most disruptive to those previously highly valued asset-light sectors, because they are now being forced into aggressive spending to avoid being left behind.

In contrast, last week saw a large-scale rotation into "AI-immune" sectors, including utilities, food, mining, construction, and telecom. This shift in funds from “new” to “old” reflects the market’s renewed interest in the valuations of capital-intensive and traditional industries.

Exchange Rate Factors and the “Nvidia Effect”

Weakness in the US dollar has also had a notable impact on corporate earnings. John Butters of FactSet points out that S&P 500 exporters with major revenue outside the United States have both higher earnings and revenue growth than those focused primarily on domestic US business.

However, Butters also emphasizes that much of the advantage of this “international risk exposure” still mainly comes down to Nvidia Corp. As the largest contributor to profits and revenue among S&P 500 firms with major international exposure, removing Nvidia causes blended earnings growth to fall from 17.7% to 12.0%, and revenue growth to slow from 11.9% to 9.9%.

Thomas Mathews of Capital Economics warns that the current rally remains highly dependent on the business models of a handful of companies. In this situation, any company-specific developments or “missed expectations” in the AI race could drag down the entire market. However, the divergence among mega-cap stocks in recent months has not prevented the broader market from staying at high levels, suggesting that a broad-based improvement in earnings driven by cyclical factors is supporting the market.

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