All good things must come to an end—even the tech rally that has propelled the market to break record after record this year.

No matter how diversified you think your portfolio may be, your gains over the past year are likely from a few key stocks known as the Magnificent 7. This small handful of big tech stocks rode AI hype all the way to the bank last year, with the group as a whole gaining 76% in 2023, far outpacing the S&P 500’s 23% gain over the same time period. In 2024, performance for these stocks has diverged, with Nvidia leading the pack and rising 145%, while Tesla is down about 1%.

But the tech rally took a turn for the worse this week. Shares of Nvidia, Apple, and Taiwan Semiconductor Manufacturing Company, the largest chipmaker by sales, tumbled on Wednesday, dragging the Nasdaq down 2.7% and the S&P 500 down 1.4% by the end of the day.

Investors were spooked after President Biden discussed trade restrictions on chipmakers. Given that presidential candidate Donald Trump holds the same position, these restrictive trade policies are likely to come into effect no matter who wins the White House this November. That’s bad news for chipmakers that not only sell in foreign markets but also depend on foreign suppliers to help build their products.

Because of how inflated AI-related stocks have become, investors were alarmed at even the slightest news of a downturn ahead and rushed to take profits. Nvidia fell 6.64% by the end of the day, while ASML plummeted 12.74% after news broke that Biden is considering using an esoteric and extremely stringent US law to impose export controls over its products.

Meanwhile, shares of TSMC sank 7.92% today after Trump argued that Taiwan, which currently has a security guarantee from the US, should “pay for its own defense.” He also said that the country “stole our chip business” in an interview with Bloomberg published Tuesday.

The result: Investors are heading for the door as fast as they can—and as investors pile out of tech, they’re pushing small-caps higher. The Russell 2000 has gained about 8% over the past week as investors search for the next big thing—which might just be undervalued small-cap stocks.

The age old question: Is AI overhyped?

Just because AI stocks have had a legendary run doesn’t necessarily mean that they’re currently overvalued.

For example, the vast majority of analysts still have “buy” ratings on Nvidia, Apple, and TSMC, according to a WSJ compilation of analyst ratings. Nothing is fundamentally wrong with these stocks—at least not yet. This earnings season should reveal just how much more fuel there is to the AI fire, and if management at AI-related companies even hints at a slowdown in sales ahead, expect the selloff to hit overdrive.

But this could be a sign that there’s value elsewhere (literally). A number of investment firms recommended other corners of the market, including small caps and utilities, as a way to balance your portfolio from the rise and fall of AI.—LB

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🟢 What’s up

• VF Corp. rose 13.64% on the news that it is selling its Supreme brand to EssilorLuxottica for $1.5 billion.
• Roche soared 7.55% after the Swiss pharmaceutical company announced it has made strides in developing a weight-loss and diabetes treatment that uses a pill rather than an injection. Competitors sank on the news, with Eli Lilly declining 3.78% and Novo Nordisk falling 3.87%.
• GitLab popped 9.34% on a report that the software developer is exploring a sale, potentially to cloud company Datadog, whose shares fell 7.35%.
• Johnson & Johnson rose a tepid 3.67% thanks to a mixed earnings announcement that included beating expectations this quarter but warning of lower profits ahead.

What’s down

• Spirit Airlines descended 10.76% to a new all-time low after warning that both earnings and revenue will come in lower than expected this coming quarter.
• Five Below plummeted 25.05% after its CEO, who has helmed the company for over a decade, announced his departure smack in the middle of a very difficult year.
• J.B. Hunt tanked 6.88% thanks to a poor second-quarter earnings report in which earnings and revenue came in well below analyst expectations.
• Charles Schwab fell yet another 5.34% as the hits keep coming. Today, the culprit was a price target downgrade from Bank of America analysts.
• Elevance Health slipped 5.96% despite beating analyst expectations this quarter, but warning that Medicaid membership declined.

‘Tis the season for earnings, a magical time of year where Wall Street analysts get to eat crow and unapologetic CEOs defend their big paychecks in light of poor quarterly performance.

Last quarter’s earnings season went well overall, with 79% of S&P 500 companies reporting a positive EPS surprise, and 61% reporting a positive revenue surprise, according to FactSet.

But while that sounds impressive, investors need to remember that earnings estimates are built to be beaten.

“Beating consensus revenue and earnings estimates tends to be a positive for stock prices, even though most market participants are well aware that chief financial officers (CFOs) are not going to go too far out on a limb when issuing guidance on anticipated results, even if they have a very optimistic outlook,” wrote Wells Fargo Investment Institute’s Scott Wren. “So conservative guidance has become the norm on Wall Street.”

Where Wall Street is investing this quarter

Despite fraudulently low expectations, there are a handful of sectors that actually do seem poised for a strong earnings season.

“Historically, we have found that sectors with strong EPS/sales revisions and guidance have been more likely to have a greater number of earnings beats than misses in the subsequent earnings season,” wrote Bank of America’s Savita Subramanian in her earnings preview. “Also, given that positive surprises tend to persist, sectors with a higher ratio of positive to negative surprises in the prior quarter may be more likely to enjoy similar results in the current quarter.”

With that in mind, Subramanian believes that industrials is the most likely sector to experience strong upside surprises this earnings season, with financials and information technology tying for second place. Meanwhile, she believes that utilities, materials, and communication services will be the worst performers as measured by positive surprises.

To get more specific, Subramanian dove into the companies that beat on both sales and earnings last quarter and that are underweighted by active funds, as well as those that Bank of America rates as “buy” and has higher expectations of this earnings season than the consensus on Wall Street.

Those parameters lead Subramanian to think that the following 10 companies are the most likely to report surprisingly positive earnings this season:

• Starbucks (SBUX)
• Amazon (AMZN)
• General Motors (GM)
• Host Hotels & Resorts (HST)
• Meta Platforms (META)
• Cboe Global Markets (CBOE)
• Cintas Corporation (CTAS)
• Apple (AAPL)
• Amphenol Corporation (APH)
• Federal Realty Investment Trust (FRT)

—MR

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• The Great Rotation (catchy name) is in full effect.
• Teens have jobs: Summer employment is booming among teenagers, reversing a decade-long decline as GenZ rolls up their sleeves and gets their hands dirty.
• Money can’t buy happiness—except, according to a new study, it actually can.
• Here’s a combo you probably never considered: Starbucks and Mercedes-Benz are partnering to build 100 fast-charging EV stations at Starbucks locations.
• “Unusually calm” isn’t how we’d describe the stock market, but with the longest stretch without a 2% or higher drop since 2007, the S&P 500 is historically tranquil.
• Taylor Swift is the reason why the Bank of England won’t cut rates this summer.

Earnings keep rolling in on Thursday, while economic data continue to take a back seat. Tomorrow we’ll hear from the Philadelphia Fed for its July business outlook report, as well as a weekly initial jobless claims report.

Before the open

• Taiwan Semiconductor Manufacturing Company (TSM) is one of the powerhouses of the chip industry, and its earnings announcement will be a clear indicator of whether or not the AI trade still has legs. Wall Street’s mixed on the matter: All 11 analysts who cover the company rate it a “buy,” but all of their price targets are below where shares trade today. Consensus: $1.38 EPS, $20.02 billion in revenue.
• Domino’s Pizza (DPZ) has had a great year, with shares up nearly 20% year to date thanks to strong earnings predicated on low-cost meals that inflation-weary Americans are hankering for. Investors will want to see more of the same this quarter, particularly when it comes to the company’s loyalty rewards program. Consensus: $3.62 EPS, $1.10 billion in revenue.

After the close

• Netflix (NFLX) has been the gold standard of the streaming era, and is likely to remain so, as its competitors all clamor to cut into the company’s commanding lead. Shareholders will be eager to learn more about its new advertising-based business and see just how accretive ads are to the bottom line. Consensus: $4.42 EPS, $8.89 billion in revenue.
• Scholastic (SCHL) isn’t one of the biggest names on Wall Street, but it’s one every kid remembers from elementary school book fairs. This is the last earnings report before summer, so shareholders will want to see a pop before the inevitable seasonal drop, with a focus on big-name releases and book club revenue. Consensus: $2.66 EPS, $552.50 million in revenue.

For those of you spending your workday browsing job sites (totally not us) and dreaming of life outside your cubicle, have we got a find for you.

Tasmania, home to more than just cartoon whirling dervishes, has put out the call for adventurous job-seekers hunting for something different. The Tasmanian Board of Tourism recently posted a series of odd jobs available this summer (winter, down in the southern hemisphere).

Jobs include Wombat Walker, Sauna Stoker, and Oyster Organizer, among others. The catch is that the jobs are unpaid, but the tourism board will cover the costs of travel, food, and lodging. And frankly, who wouldn’t be willing to pay to work as a Wine Whisperer for a few days?—MR