The Tech Rally Could Be Running on Borrowed Time

Nick Raich (0:00)

2027, so the multiples have contracted this year, because the market's saying, hey, next year might be those storm clouds on the horizon, they're willing to pay a little bit less at this point for every future dollar of rights.

SPEAKER_2 (0:12)

Right, it seems like the earnings growth has been actively trying to catch up with those multiples as well throughout the course of the year. So I guess it's the way you come at the perspective, you come at it with, but as far as those storm clouds that you're talking about, I mean, you know, which sectors are likely to fall first, for lack of a better phrase? I mean, where should we be getting the umbrella out?

Nick Raich (0:35)

Well, it's obviously since March 30th. There was a mini correction earlier this year when the Iran conflict started in the market, was worried that it was going to derail the economy, the rise in energy prices, but it was underestimating the tailwind from the AI infrastructure build out. So we got monster revisions up from SanDisk, Micron, the memory plays, and that really supported and offset the drag on earnings estimates. And we've seen the earnings expectations improve and technology since March 30th out of the 11 sectors is the only one that's outperforming the actual S&P 500 itself. So this has been a technology based rally since 2022 and certainly since March 30th.

If the storm clouds do come in 2027, those high beta place tech will be probably the area we want to underweight. But through year end, we're still overweight tech, a little less than we were six months ago, but still have an overweight tech next year. Could be a totally different story though.

SPEAKER_3 (1:33)

And Nick, if the storm clouds are still offshore, but we're on potential hurricane watch for 27, what specific signals are you looking for to know that we are going to see the storm hit land?

Nick Raich (1:46)

Yeah, you'll get a warning sign. That's a great question. What we're looking at is the earnings estimate changes on a rate of change basis.

And in the summer, the estimates went up, but not quite as much as they did in the spring. So now we're in the fall. If we see a second quarter in a row of weakening on a rate of change basis earnings for the overall S&P 500, that'll be two quarters in a row of weakening earnings.

If we continue to go to all time highs in stock prices as we're forecasting, that would be a two quarter divergence. And that was, if that happens, that'll be the eighth time it's happened in the last 35 years. And it's always forewarned of every major correction and every bear market. So that's what we're going to look at this earning season, is not just that the revisions are going up by how much, and then compare that to three months ago to see if the trends are weakening further. And if they do and prices go up to a high, that divergence, that negative divergence will be the signal that will look to start de-risking for 2027

SPEAKER_2 (2:45)

Are you as worried about the financials as some of the traders are, given the breakdown we've seen of late on a couple of stumbles around, obviously what the CEOs have been warning about. We've got the data center pushback. We've got the cooling IPO market with a bunch of these delays as well, and not to mention the yields.

Nick Raich (3:07)

Yeah, well, we'll first talk about the yields because those rates are rising. And the level of interest rates are maybe one of the most important variables where future earnings are going to be.

We don't care as much that the 10-year now is at 5.31 on the 10-year. That can keep going higher so long as it doesn't impact the earnings negatively.

When we see those start to really hurt the earnings impact, then we know the level of interest rates is going to be a drag. And like I said, rates are rising this year, and those very well could be a drag on 2027 earnings. So we're looking at that very closely. And that could be one reason why we're seeing outlooks in the first 16 companies that have reported third quarter earnings and 16 companies have already reported earnings. A lot of people don't realize that. But these are the companies that report August quarter ends. So I'm talking Micron, Faxset, Nike, Lenar, they've all reported over the last month in August quarter end. And we're looking at how their estimates are going up, and they're going up for the next quarter, but they're going up at a lesser rate. So that might be the early litmus test barometer, if you will, for how overall earnings season is going to shape up. Where we're forecasting the revision trends are probably going to weaken further, and those level of interest rates might be a key reason why that's happening.