With 136 S&P 500 companies reporting last week, earnings season is 41% complete, and 78% reported better-than-expected profits for the quarter. The second quarter earnings season is entering its busiest reporting week yet, with 172 S&P 500 companies scheduled to report. A more detailed earnings season preview is available here. Companies scheduled to report include McDonald’s (MCD), Starbucks (SBUX), Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN), Apple (AAPL), Chevron (CVX), Exxon Mobil (XOM), and Berkshire Hathaway (BRK/A, BRK/B).

The S&P 500 fell 0.8% for the week. The Magnificent 7, consisting of Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN), Apple (AAPL), NVIDIA
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(NVDA), Alphabet (GOOGL) and Tesla (TSLA) led the decline again, losing 3.9%. A deep dive into the Magnificent 7’s characteristics is here . Tesla missed estimates last week, but Alphabet’s earnings beat expectations. The biggest laggard since July 9 is Telsa (TSLA), which took over after last week’s poor earnings. Meta (META) and NVIDIA (NVDA) have the two highest expected year-over-year earnings growth rates and are the second worst performers in the Magnificent 7 since July 9.

The market rotation that began on July 9 continued with mega-cap tech stocks falling despite better earnings growth and weighting in the index, while smaller companies outperformed. Small-cap stocks are up 11.4%, while the Magnificent 7 and the S&P 500 are down 10.9% and 2.1%, respectively. While not as strong as the smallest companies, mid-cap stocks have joined the rotation party, gaining 4.5%. Breadth of the stock market has improved significantly, with the average S&P 500 stock up 2.2% since July 9 after the average stock lost value in the second quarter.

The less economically sensitive defensive stocks slightly outperformed the more economically exposed cyclicals on the week. This move still looks more like a reversal of the peak of cyclical outperformance following last week’s rate-cut-friendly inflation report than a sign of looming economic troubles. The outperformance of banks and small-cap stocks provides further evidence that this is not a sign of rising recession risk.

According to FactSet, several sectors, led by industrial and communications services, helped boost earnings growth for the week. Better-than-expected earnings from GE Aerospace (GE), Lockheed Martin (LMT) and RTX Corporation (RTX) were key contributors within the industrials sector. Positive earnings surprises from Alphabet (GOOGL) and Comcast (CMCSA) led the improvement in the communications services sector. These positive earnings surprises were partially offset by weakness in health care earnings. Earnings estimates were cut for Vertex Pharmaceuticals (VRTX) related to the accounting treatment of its acquisition of Alpine Immune Sciences.

Sales growth is closely linked to nominal GDP growth, which combines economic growth after inflation (real GDP) with inflation. Last week’s GDP report showed that nominal GDP growth accelerated to 5.8% year-on-year for the second quarter, providing a tailwind for corporate sales growth. At this point in the earnings season, sales growth has exceeded expectations.

So far, blended earnings performance has exceeded expectations at the end of the quarter. Combining actual results with consensus estimates for companies yet to report, the blended earnings growth rate for the quarter improved to +9.8% year-on-year, above expectations of +8.9% at the end of the quarter.

The second-quarter GDP report showed the U.S. economy grew at an annualized rate of 2.8%, well above the consensus of 1.9%.

Domestic demand appears robust, excluding the more volatile components of inventories and net exports. Real final sales to private domestic buyers, which measure private demand in the domestic economy, remained healthy at 2.6 percent in the second quarter, maintaining the same pace as in the first quarter.

The solid second-quarter GDP report should not raise concerns about economic growth, and the inflation component should provide some relief after its first-quarter spike. The pace of inflation as measured by the Federal Reserve’s preferred measure, core PCE, slowed to 2.9% from 3.7% quarter-on-quarter annualized.

The Fed is expected to hold off on making rate changes on Wednesday, but Chair Powell should hint that cuts could begin soon. Labor market normalization and strengthening inflation trends make the Fed’s September rate cuts the most likely scenario. Moreover, Friday’s monthly jobs report remains crucial, as labor market softening is vital to any cuts that begin in September. The total expected rate cuts in 2024 are between two and three, leaving room for three consecutive cuts of 25 basis points (0.25%) in September, November and December.

Earnings season enters its busiest week yet, with four of the Magnificent 7, Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN) and Apple (AAPL), reporting earnings. While Wednesday’s Fed meeting won’t include any rate cuts, markets will be disappointed if Chairman Powell doesn’t provide a harbinger that the easing cycle could begin soon. Friday’s monthly jobs report closes the week with critical inflationary concerns about the health of the labor market, as it would be harder for the Fed to begin cutting rates while economic growth remains solid unless the labor market continues to soften.