Where are large-cap tech stocks heading? Goldman Sachs: Keep an eye on this indicator

In recent weeks, as investors historically shifted their focus to small-cap stocks, the rise of large-cap tech stocks suddenly cooled off.

Since early July, the Russell 2000 Index (RUT) has risen by about 7%, while the S&P 500 Index (SPX) has only risen by 1%. This stark contrast with the outperformance of large-cap tech stocks over small-cap tech stocks in the past one, three, five, and ten years.

For large-cap tech stocks to reverse the trend of significantly underperforming the market in July, the only opportunity is to remind investors why their long-term performance will be significantly better than the market: strong earnings growth.

Goldman Sachs strategist David Kostin said in a report last Friday that second-quarter earnings will show whether large-cap tech stocks can recover their strength so far this year.

Kostin said, "Unless there is a significant change in the macro environment, or second-quarter earnings reports lead analysts to raise revenue expectations for the next few quarters, the recent trend of small-cap stocks outperforming the market may continue."

Tesla (TSLA) and Alphabet (GOOG) will release earnings after the market closes this Tuesday, giving investors their first taste of earnings from large-cap tech companies. Following that, Microsoft (MSFT) will report earnings on July 30, Meta Platforms (META) on July 31, and Apple (AAPL) and Amazon (AMZN) on August 1.

Raising future earnings growth expectations is key because the growth of large-cap tech stocks is slowing down while other companies' growth is accelerating.

The report states that the market generally expects Amazon, Alphabet, Meta Platforms, Microsoft, and NVIDIA's revenue growth to decrease from 17% in the second quarter to 14% in the fourth quarter. This trend repeats itself every year.

Kostin said, "In contrast, the median revenue growth of S&P 500 index component companies will accelerate, despite the slowdown in growth."

Earnings expectations for the S&P 500 Index and large-cap tech stocks are narrowing

Kostin believes that analysts' revisions to revenue growth for large-cap tech companies are a key indicator of when the 2000 Internet bubble will end. This time, in the midst of the endless hype around artificial intelligence, it may once again become a useful indicator of investor attention.

Kostin said, "In the late 1990s Internet boom, revenue revisions were a key variable to watch because they ultimately signaled when the momentum would continue to reverse."

If large-cap tech companies outperform expectations and raise their forward sales guidance, the S&P 500 Index will resume its outperformance. Otherwise, small-cap stocks will continue to outperform the market.

Factors driving the recent rebound in small-cap stocks include: accelerating earnings growth, slowing inflation, imminent Fed rate cuts, and the increasing possibility of Trump serving as president in 2025