The S&P 500 lost 2.3% on Wednesday as earnings announcements from several major US companies fell short of expectations.
Google owner Alphabet (NASDAQ:GOOGL) saw its shares fall 5% due to investor concerns over rising AI-related capital expenditures, despite better-than-expected second-quarter earnings.
Such reaction further highlighted that market optimism regarding the tech sector's outlook has set a high bar for companies to meet.
Tesla (NASDAQ:TSLA) saw an even steeper decline after reporting its lowest profit margin in over five years.
"After a roughly 20% rally since the start of the year, a pullback at some point was always a possibility," UBS strategists commented.
"The recent smooth ascent of the S&P 500 has been unusual. The index had gone more than 350 trading sessions without a drop of more than 2%—its best run in 17 years,” they added.
Furthermore, investors have already factored in much of the positive news regarding AI commercialization, raising expectations for tech companies, UBS noted.
TSMC (TSM), the world's largest contract chip manufacturer recently projected that AI chip demand would exceed supply until 2026, extending from 2025, while one of the largest semiconductor equipment companies anticipated strong demand into 2025.
Nonetheless, UBS strategists maintain an optimistic stance on US equities.
"Despite the recent market setback, we believe the earnings season—which is still at a relatively early stage—is likely to support confidence,” they wrote.
“While we expect further signs that there is some softening in profit momentum, results so far remain consistent with our forecast for 10-12% S&P 500 earnings-per-share growth, which would be the best outcome in more than two years."
They also foresee a broadening of earnings growth beyond the Magnificent 7, the leading growth and tech stocks driving the recent rally. The current earnings season is expected to show the first growth in earnings per share for the S&P 493 since 2022, UBS highlighted.
The bank’s team believes this broadening of earnings growth will make the recent rally more sustainable. Also, they expect the monetary policy easing cycle to provide additional tailwinds, with slowing inflation enabling the Federal Reserve to cut rates at its September policy meeting.