Mag 7 Results Preview: Prepare for a Bubble Burst (SP500)

The pivotal results season

Signs of an economic slowdown are mounting, with some leading indicators hovering at levels typically associated with a recession. At the same time, the S&P 500 is trading at valuation multiples historically associated with a bubble.

So if the stock market is in a bubble and we are facing a recession, investors should prepare for the bubble to burst and a recessionary bear market – a major pullback.

The stock market bubble is centered around several mega-cap technology companies, known as the Magnificent 7. Despite the obvious slowdown in the economy, these mega-cap stocks continue to surge under the Gen AI theme, pushing the S&P 500 Index to new highs.

This mega-cap bubble will likely only burst if the mega-caps’ financial results disappoint, either by missing earnings/sales estimates or by providing only weak guidance. In fact, the dot-com bubble burst in March 2000 with Yahoo’s weak earnings report.

The current situation is very similar to that of March 2000: the economy is sliding into recession, monetary policy is tight, and the stock market is in a bubble. The key question then is whether mega-cap bubble stocks will disappoint in the upcoming Q2 2024 earnings season, as they did in March 2000.

In my view, the slowdown in the economy should be reflected in corporate earnings reports in the second quarter of 2024. So there is a good chance that we will see a significant decline in earnings from one of the mega-caps, which could burst the bubble.

Overview of earnings estimates

The bottom-up analyst earnings estimate for Q2 2024 for the S&P 500 is 8.1% YoY earnings growth and 9.2% YoY earnings growth for 2024, as shown in the CFRA chart below.

More importantly, the analysis predicts earnings growth of 14.6% year-on-year for 2025.

For 2024, earnings growth is concentrated in the information technology, communication services and consumer discretionary sectors, which include Mag 7 stocks. However, accelerated earnings growth is expected across all sectors in 2025, including value and small stocks.

Thus, analysts are very bullish on Mag 7 shares in 2024, and see major earnings growth broadening in 2025, which can only be justified with accelerated economic growth in 2025.

But the economy is currently slowing dramatically and we could already be in a recession if some key indicators, such as the Sahm indicator, are any indication. So clearly the earnings estimates for 2024 and 2025 are unrealistic: they do not even anticipate a minor slowdown. So that is part of the bubble: unrealistic earnings expectations.

So, in my view, mega-caps will likely start to feel the current economic slowdown and, as a result, cut their earnings forecasts, potentially bursting the bubble.

Mag 7 themes

So, let’s take a look at how each Mag 7 stock has fared since the release of Q1 2024 earnings. First, the S&P 500 (SP500) is up 7% over the past 3 months, since the start of Q1 2024 earnings season.

However, over the past three months, only 231 stocks in the S&P 500 have gained, while 272 have declined. Additionally, the Equal Weighted S&P 500 (RSP) is actually down -1.63% over the past three months.

Thus, Mag 7 stocks are leading the index higher, while most stocks are falling.

This is the theme behind each Mag 7 stock.

• NVIDIA (NVDA) is up 43% in the past 3 months, and since the last earnings report, it has skyrocketed due to 10-1 Stock Splitwhich has attracted a lot of interest from retail investors. Nvidia won’t announce another stock split in the second quarter, but it will likely report single-digit quarterly sales growth, which is simply not enough to justify the high price-to-earnings ratio of 74. Thus, NVDA is likely to fall after the second-quarter results unless it reveals a major share buyback.
• Apple (AAPL) is up 34% over the past 3 months, despite a 4% decline in quarterly revenue from a year earlier. Apple likely saw a surge due to $110 billion in additional share buybacks and early release of Apple Intelligence. Apple now needs to ensure that the iPhone replacement cycle will be massive due to the AI ​​upgrade; otherwise, the stock is likely to fall sharply after the earnings release, given the PE ratio of 36.
• Tesla (TSLA) is up 53% over the past 3 months despite missing both earnings and revenue in the first quarter as the company refocused into an AI robotics companyGiven the price-to-earnings ratio of 65, TSLA is likely to fall after the release of Q2 results as robo-taxis are still just a “story” and declining demand for electric vehicles will start to affect the health of the balance sheet.
• Alphabet (GOOG) (GOOGL), also revealed a $70 billion in stock buybacks and began paying dividends in the second quarter, and the stock has climbed 25% in the past three months. Alphabet will have to continue to raise its forecast for its cloud business, but the slowing economy could start to affect the advertising business, which could cause the stock to fail and fall.
• Amazon (AMZN) also revealed a $70 billion in stock buybacks Amazon began paying dividends in the second quarter, and the stock is up a modest 8% over the past three months. Amazon will also need to continue to raise its guidance for its AWS cloud business, but the slowing economy could start to affect its retail business, which could result in a miss.
• Meta (META) has already provided weak indications In the second quarter, the stock fell 12% after the earnings release. However, the stock has rebounded to rise 2% over the past three months, in sympathy with other mega-caps. Meta has significant investments in AI, and investors will be watching ad revenue for evidence of AI monetization. However, an economic slowdown is likely to hit ad revenue, and Meta is likely to miss guidance expectations again.
• Microsoft (MSFT) is also paying close attention to cloud revenue growth and next-generation AI capital spending. The stock is up 10% over the past three months, but its price-to-earnings ratio is very high at 41. An economic slowdown could start to affect Microsoft’s sales in other sectors.

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Consequences

Mag 7 stocks have led the S&P 500 higher over the past three months. However, this move has been driven by non-fundamental speculative themes, such as stock splits and share buybacks.

In my opinion, Meta is an example of what is happening to the rest of the Mag 7 stocks – Meta missed Q2 guidance, and it is likely that other Mag 7 stocks will miss Q3 guidance.

The economic slowdown is a systematic event and it will have to start affecting the business operations of Mag 7 companies. Thus, unrealistic earnings expectations will have to match reality, and this could happen during the second quarter earnings season.

Given the importance of Mag 7, the S&P 500 (SP500) is likely to fall sharply when the Mag 7 bubble bursts.