This chart shows why the stock-market rally should broaden out later this year

By Joseph Adinolfi

The earnings-growth differential between the largest S&P 500 companies and the rest is expected to shrink later in 2024

Is this the best argument for why the stock-market rally should continue to broaden out? That is, assuming the current market pullback proves to be temporary.

After expanding at a blistering pace over the past year, earnings growth for the largest S&P 500 firms is expected to slow during the coming quarters. Fortunately, just as profit growth for Big Tech begins to sag, Wall Street analysts expect the rest of the companies in the S&P 500 to pick up the slack.

This could help drive the S&P 500 higher heading into the second half of the year, and perhaps even allow other corners of the market to steal the mantle of leadership from the megacap technology stocks that have dominated U.S. stock returns over the past year.

"Given the high correlation between tech's outperformance in stocks vs. earnings, we expect the narrowing growth differential to be a catalyst for the market to broaden out," said Savita Subramanian, a top equity strategist at BofA Global Research, who touched on this theme in a report shared with MarketWatch on Monday.

The so-called Magnificent Seven - a group of seven megacap companies that includes Apple Inc. (AAPL), Meta Platforms Inc. (META), Nvidia Corp. (NVDA), Microsoft Corp. (MSFT), Tesla Inc. (TSLA) , Amazon.com Inc. (AMZN) and Alphabet Inc. (GOOG) (GOOGL) - grew their earnings by a whopping 63% during the fourth quarter of 2023, accounting for practically all of the index's earnings growth.

But according to FactSet estimates, the pace of growth for the largest S&P 500 firms is expected to have slowed during the first quarter of 2024. The 10 largest companies in the S&P 500 are expected to see earnings growth of 32% for the first quarter, compared with a 0.4% year-over-year decline for the rest of the index.

Fortunately, by the second quarter, the other 490 companies in the index are expected to see earnings growth start picking up, helping to push aggregate earnings for the index's constituents higher still. Wall Street analysts ultimately expect S&P 500 companies to grow earnings by roughly 11% in 2024.

And by the fourth quarter, growth is expected to have roughly evened out, with the top 10 stocks expected to see growth of 17.2% while the other 490 companies see growth of 17.8%, according to FactSet data.

Big Tech's torrid stock-market gains will likely slow as a result, seeing as their outperformance has been closely tied to their exceptional earnings growth, Subramanian said.

This should give other stocks and sectors an opportunity to take their place. In fact, there are already signs that the long-awaited rotation in market leadership is already underway. Energy stocks XX:SP500.10 were the best-performing S&P 500 sector in March as crude-oil prices rose to their highest levels since October.

Also, the S&P 500 is outperforming the tech-heavy Nasdaq Composite in 2024, another notable shift from last year's Big Tech-driven market, according to FactSet data.

According to Subramanian, earnings growth has contributed mightily to stocks' gains since the start of 2024.

Subramanian's calculations show that while macro factors like interest rates drove markets for much of the past two years, that has begun to shift in 2024, with earnings expectations playing a bigger role. Since the bull market began in October 2022, the S&P 500 has gained nearly 40%, according to FactSet data.

So long as earnings hold up, the pullback in stocks that started in April should be temporary, according to a team of strategists at UBS Group.

The S&P 500 SPX was down 3.7% from its late-March peak early Tuesday afternoon at 5,060 points, leaving it little-changed on the day after seesawing between gains and losses earlier. The Nasdaq Composite COMP was up 0.1% at 15,892 points in recent trade, while the Dow Jones Industrial Average DJIA was up 105 points, or 0.3%, at 37,845.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

04-16-24 1345ET

Copyright (c) 2024 Dow Jones & Company, Inc.