US stocks face a test of "rotation trading": Tech giants' strong earnings are still "tasty"! The performance guidance of small and medium-sized stocks and value stocks is crucial for continued gains.

As the latest earnings season for US stocks kicks off, investors' preference for companies benefiting most from accelerated economic growth will face a serious test. Funds that have poured into tech giants over the past three years are now shifting to stocks of banks, consumer goods manufacturers, and material producers. Investors are betting that with the US economy accelerating in 2026, these industries are poised to outperform the market. However, the problem for investors is that large tech companies will still be the main contributors to fourth-quarter profit growth of S&P 500 index component companies. According to Bank of America Corp data, tech companies in the index are expected to achieve a 20% year-on-year growth, while non-tech companies' profit expansion is expected to slow from 9% to just 1%. This will put significant pressure on value companies like Caterpillar Inc. (CAT.US), Procter & Gamble Company (PG.US), and JPMorgan Chase & Co. (JPM.US). Investors need corporate America to reaffirm Wall Street's mainstream prediction: the US economy is expected to experience explosive growth in the first half or even the entire year. Piper Sandler & Co.'s Chief Investment Strategist Michael Kantrowitz said, "Earnings guidance will be a crucial signal. At the beginning of this year, we saw broad stimulus policy benefits for the first time, which is vital for achieving sustainable profit growth." He is most bullish on the transportation, housing-related industries, and manufacturing. Recently, the US stock market has reflected optimism about the future of the US economy. Since early November, investors have generally expected corporate executives to be optimistic about growth prospects. Small-cap stocks and so-called value stocks have recently been favored, which has always been a reflection of investor confidence in the US economy. The small-cap stocks in the US stock market have seen their longest stretch of outperformance over large-cap stocks in seven years. Data shows that the Russell 2000 small-cap stock index, which closed at a historic high on Monday, has outperformed the S&P 500 index for seven consecutive trading days. The last time the index showed a longer leading trend was back in January 2019 when the US stock market was struggling to rebound from a nearly bear market crash. In December 2018, amid multiple factors such as rising interest rates, US-China trade war concerns, and economic slowdown fears, the S&P 500 index fell 9.2%, while the Russell 2000 index plummeted 12%. However, in the following January 2019, the Russell 2000 index rebounded strongly by 11%, compared to a 7.9% increase in the S&P 500 index during the same period. However, these trading strategies may face challenges based on institutional forecasts of future earnings for the next year. An analyst team led by Wendy Soong projects a profit growth rate of 9% for S&P 500 value stocks, only a third of the pace of growth stocks. Technology stocks, the largest sector in growth stocks, are way ahead with an expected profit growth rate of 30%. Nevertheless, there are reasons to remain confident. Industrial companies in the S&P 500 index are expected to drive profit growth by 13%, while companies producing non-essential consumer goods and services are expected to grow by 12%. Data shows that healthcare, materials, and essential consumer goods companies' profits are also expected to grow by nearly 10%. Kantrowitz from Piper said, "The Fed's loose monetary policy, falling oil prices, loosening lending standards, and the 'Build Back Better Act' are all factors that could benefit the lower end of the economy and the stock market." Strong forecasts are crucial for supporting the rotation of funds into tech stocks, especially after years of dominance by a few giant AI companies. The Fed's loose monetary policy has reinvigorated sectors sensitive to economic conditions, while traders are questioning the sustainability of AI trading and prompting fund managers to diversify funds from long-term winners in the bull market. Investors are adapting to the rotation trend of funds. Data from Deutsche Bank Aktiengesellschaft shows a continued decrease in allocations to large growth stocks and tech stocks, while allocations to small-cap stocks have reached their highest level in nearly a year. Recent fund flows have also confirmed this rotation trend. Nearly $900 million flowed out of the technology sector last week in specialized funds, while $8.3 billion flowed into other sectors, with materials, healthcare, and industrial sectors attracting the most significant inflows. Matt Maley, Chief Market Strategist at Miller Tabak + Co., said, "The emergence of some new political issues for GEO Group Inc could have a significant impact on the market. However, this earnings season is crucial for the S&P 493 index and small-cap stocks. Expectations for these earnings are quite high, so the bar is also quite high." He added that although institutional investors have reduced holdings in tech stocks, they are still generally overexposed, so they are looking for areas that can "rotate"; therefore, meeting earnings expectations should trigger a greater rotation in the stock market.