Earnings Derail Stock Rally Over Doubts on AI, Consumer Strength

(Bloomberg) — The latest earnings reports are fanning two worries that were already gnawing away at the US stock market: That the euphoria about artificial intelligence had run too far and that — at some point — consumers spending will start to stall.

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While profits overall are still expanding at a solid pace and banks’ earnings have continued to swell, those concerns have derailed a stock-market rally that until this month kept pushing major indexes to fresh record highs.

The Nasdaq 100 Index slid 2.6% in its third straight weekly loss after Alphabet Inc.’s results stoked a broader concern about how long it will take for investments in artificial intelligence to pay off. At the same time, updates from Southwest Airlines Co., United Parcel Service Inc., Whirlpool Corp. stoked worries about a potential pullback by consumers.

That’s heightened the stakes as earnings continue to roll out next week, including those from the tech bellwethers Microsoft Corp., Meta Platforms Inc., Amazon.com Inc. and Apple Inc.

“The setup for the next week is the bar is as high as it’s ever been and the headwinds are as strong as they’ve ever been,” said Max Gokhman, senior vice president at Franklin Templeton Investment Solutions.

The sentiment is a shift from what held sway during much of this year, when optimism about soft landing in the economy and investor obsession with all things artificial intelligence pushed the S&P 500 into 38 records.

The direction of the economy has remained well intact, with recent data showing solid economic growth and easing inflationary pressure. That bolstered bets that the Federal Reserve will start cutting rates sooner than expected, fueling gains in small-cap stocks that generally have a higher debt burden.

To be sure, there have been plenty of bright spots in the earnings picture. About 69% of companies in the S&P 500 that have already posted their results reported higher per-share earnings than a year ago, data compiled by Bloomberg Intelligence as of Friday morning show. And banks surpassed the sell-side’s expectations, while a profit squeeze for industrial companies may be coming to an end.

Moreover, those that posted disappointing figures have generally not been severely punished, at least so far. Companies in the S&P 500 that have trailed projections on both earnings per share and sales have underperformed the broader S&P 500 Index by an average of 1.6% within a day of reporting, the least since 2017, according to data compiled by Bloomberg Intelligence.

Banks surpassed the sell-side’s expectations, and a profit squeeze for industrial companies may be coming to an end.

But the scale of the market’s run up this year has left some investors wary, particularly when it comes to the big technology companies. With Alphabet, Microsoft, Meta and Amazon.com Inc. all investing heavily in the promise of artificial intelligence technology, investors are increasingly questioning how much it will pay off.

The Google parent reported sales and cloud revenue that beat expectations. At the same time, capital spending rose to $13.2 billion in the second quarter, exceeding Wall Street’s estimates.

“It really feels like we are moving from a ‘tell me’ story on AI to a ‘show me’ story,” said Ohsung Kwon, equity and quantitative strategist at Bank of America Corp. “We are basically at a point where we’re not seeing much evidence of AI monetization yet.”

With weeks still to go before major US retailers roll out their earnings, early reports have indicated consumers are continuing to feel the pinch of high interest rates and still elevated inflation, particularly in the low-income category. Second quarter EPS growth in both consumer staples and consumer discretionary sectors is sitting at the lowest level in two years.

Whirlpool lowered its full-year earnings forecast, as consumers continued to shy away from big-ticket appliance purchases amid a weakening housing market. Shares of a frozen potato supplier Lamb Weston Holdings Inc. sank by the most on record on Wednesday as earnings and guidance missed analysts’ expectations.

American Airlines Group Inc. and UPS trimmed earnings forecasts for the year. United Airlines Holdings Inc.’ EPS came ahead of consensus estimates, but the carrier said profit expectations for the third quarter would fall short of Wall Street’s expectations.

Matt Maley, chief market strategist at Miller Tabak + Co. said the UPS and airline results raise “concerns about how strong the economy is.”

“And if people are shipping less,” he said, “then it tells a lot about weakness in trade.”

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