As the latest US earnings season commences, investors' preference for companies poised to benefit most from an accelerating economy is set for a significant test. Capital that flooded into tech behemoths over the past three years is now rotating towards stocks of banks, consumer goods manufacturers, and materials producers. Investors are betting these sectors will outperform as the US economy gains momentum through 2026. However, a key challenge for investors is that large technology companies are still projected to be the primary contributors to fourth-quarter profit growth for S&P 500 constituents. According to Bank of America, technology firms within the index are expected to post a 20% year-over-year profit increase, whereas earnings expansion for non-tech companies is anticipated to slow from 9% to a mere 1%. This situation places immense pressure on the guidance provided by value-oriented companies like Caterpillar (CAT.US), Procter & Gamble (PG.US), and JPMorgan Chase (JPM.US).

Investors are seeking confirmation from Corporate America that aligns with Wall Street's prevailing forecast: an explosive economic growth phase in the first half, or even the entirety, of the year. Michael Kantrowitz, Chief Investment Strategist at Piper Sandler & Co., stated, "Earnings guidance will be a critical signal. For the first time this year, we are seeing broad-based stimulus tailwinds, which are essential for sustainable profit growth." His most favored sectors include transportation, housing-related industries, and manufacturing. Recent market activity in US stocks reflects this optimism towards the US economic outlook. Trading patterns since early November indicate a widespread investor expectation that corporate executives will express optimism about growth prospects.

Recently, small-cap stocks and so-called value stocks have gained significant favor, historically a barometer of investor confidence in the US economy. US small-caps are experiencing their longest streak of outperformance relative to large-caps in seven years. Data shows the Russell 2000 small-cap index, which closed at a record high on Monday, has now outperformed the S&P 500 for seven consecutive sessions. The last time this index maintained a longer lead was back in January 2019, when US stocks were recovering from a sharp decline that nearly plunged the market into a bear market. In December 2018, hit by rising interest rates, US-China trade war fears, and economic slowdown concerns, the S&P 500 fell 9.2%, while the Russell 2000 plummeted 12%. Subsequently, in January 2019, the Russell 2000 surged 11%, compared to a 7.9% gain for the S&P 500.

However, these trading strategies may face a test based on institutional forecasts for earnings over the next year. An analyst team led by Wendy Soong projects profit growth for S&P 500 value stocks at 9%, just one-third of the growth rate expected for growth stocks. Technology stocks—the largest component of growth stocks—are far ahead, with an anticipated profit growth rate of 30%. Despite this, there are reasons for confidence. Industrial companies within the S&P 500 are expected to drive profit growth of 13%, while companies producing discretionary goods and services are forecast to grow by 12%. Data indicates that healthcare, materials, and consumer staples companies are also poised for nearly 10% profit growth.

Piper Sandler's Kantrowitz commented, "Fed monetary policy easing, lower oil prices, looser lending standards, and the 'Big and Beautiful' bill are all factors that could benefit the lower-end segments of the economy and stock market." Strong forecasts are crucial for supporting the rotation away from tech stocks, especially after years of market dominance by a handful of giant AI-focused companies. The Federal Reserve's accommodative monetary policy has reignited interest in economically sensitive sectors, coinciding with traders questioning the longevity of the AI trade, prompting fund managers to diversify capital away from the long-term winners of the bull market.

Investors are aligning with this rotation trend. Data from Deutsche Bank shows positioning in large-cap growth and tech stocks continues to decline, while allocation to small-caps has reached its highest level in nearly a year. Recent fund flows corroborate this rotation. Among sector-specific funds, technology experienced significant outflows, with nearly $900 million leaving the sector last week; meanwhile, other sectors attracted $8.3 billion in inflows, with materials, healthcare, and industrials seeing the most notable inflows.

Matt Maley, Chief Market Strategist at Miller Tabak + Co., said, "The emergence of new geopolitical issues could significantly impact the market. However, for the S&P 493 and small-cap stocks, this earnings season is critically important. Market expectations for these earnings are quite high, so the bar is set high as well." He added that although institutional investors have reduced their tech holdings, they generally remain overweight and are therefore seeking areas to rotate into; consequently, even earnings that merely meet expectations could trigger a more substantial stock market rotation.