Technology stocks just had their worst day in nearly two years, and hedge-fund manager Bill Ackman received more bad news. But first, let’s focus on an important analysis by Michael Mauboussin, head of consilient research at Morgan Stanley Investment Management’s Counterpoint Global and adjunct professor at Columbia Business School, and his colleague Dan Callahan. Mauboussin and Callahan explored the dynamics of equity issuance and retirement, revealing that companies often simultaneously buy and sell their own stock. They engage in stock buybacks while issuing shares to acquire other companies, make investments, or compensate employees with stock-based compensation. Their research concentrated on Russell 3000 companies with at least $1 billion in sales, analyzing data from 1,350 stocks between 2021 and 2023. They discovered that companies aggressively buying back their stock while sparingly using stock-based compensation outperformed the market. Even companies that were not aggressive with buybacks kept pace as long as they didn’t heavily compensate employees with stock. They acknowledge that other factors, like company fundamentals and interest rates, also influence returns. However, they emphasize the importance of understanding the impact of equity issuance on returns to make informed capital allocation decisions.

Alphabet Inc., the parent company of Google, has shown cost discipline in various areas, yet several factors could impede margin expansion in the third quarter. Despite surpassing earnings and revenue expectations on Tuesday afternoon, Alphabet’s stock still declined by the end of the extended session. Several points in the latest figures drew investor scrutiny. For instance, YouTube’s revenue was lower than expected and decelerated compared to the first quarter. Management explained that YouTube faced easier comparisons in the first quarter, which was up against a period of negative growth, while the second-quarter results were compared to the beginning of ramping advertising revenue from Asian e-commerce players like Temu. A more significant issue for investors was highlighted during the company’s earnings call. Alphabet’s executives pointed out trends that could impact margin expansion in the third quarter. President Ruth Porat mentioned that headcount could rise as the company hires college graduates and that Alphabet faces higher “depreciation and expenses associated with higher levels of our investment in technical infrastructure.” Wall Street analysts, such as Ben Reitzes from Melius Research, indicate that the market might be concerned about the pace at which Alphabet can widen its margins in the near future. Reitzes noted that while Alphabet’s 32.4% overall operating margin in the June quarter exceeded expectations, any comments suggesting a slower pace of margin expansion attract attention given the current emphasis on efficiency. Significant investments in technical infrastructure, driven by Alphabet’s ambitious artificial intelligence goals, are key factors influencing spending. Rivals like Meta Platforms Inc., Amazon.com Inc., and Microsoft Corp. are making similar investments. Porat’s comments indicate that third-quarter operating margins will reflect increased depreciation and expenses from these investments. Reitzes emphasized the importance of monitoring depreciation trends on earnings per share and gross margins, especially for leading tech firms known as the Magnificent 7, which include Microsoft, Amazon, and Meta. Alphabet’s shares fell 2% in Tuesday’s extended session, reversing an earlier upward trend. If this movement continues into Wednesday’s regular session, it would mark Alphabet’s most subdued stock-price reaction to earnings since shares fell 0.1% following the March-quarter report last year.

BofA strategists highlight that historically, a lower Treasury yield and an improving manufacturing PMI have driven the outperformance of the equal-weighted S&P 500 index. Recently, a surge in U.S. small-cap stocks has led investors to speculate whether this marks a shift away from this year’s Big Tech frontrunners. According to BofA Global Research strategists, a lasting stock-market rotation depends on the 10-year Treasury yield remaining below 4% and the ISM manufacturing PMI index staying above 50%. Historically, the equal-weighted S&P 500 index has outperformed the market-cap-weighted S&P 500 90% of the time when the 10-year Treasury yield dropped by more than 1 percentage point from its 12-month peak, and the ISM manufacturing PMI improved by over 4 percentage points from its 12-month low, as noted by BofA strategists led by Ohsung Kwon. For this rotation to continue, the 10-year yield needs to be around 3.99%, below its 52-week high of 4.99% recorded on October 19, and the ISM manufacturing PMI index should be above 50%, indicating expansion in the manufacturing sector. “The manufacturing economy is experiencing its second-longest downturn in history, with 21 months without two consecutive months of PMI above 50%,” Kwon and his team wrote, attributing this mainly to the destocking cycle, which they expect to moderate in the second half of 2024. The Institute for Supply Management’s manufacturing index fell to 48.5% in June from 48.7% in the previous month, with the lowest level in the past 12 months being 46.5% in July 2023. A PMI below 50% indicates contraction in the sector. On Monday, the 10-year Treasury yield increased by 2.1 basis points to 4.259%, influenced by speculation that Vice President Kamala Harris might become the Democratic Party’s presidential nominee. This year, the 10-year rate has risen by nearly 40 basis points due to persistent inflation concerns, keeping the Federal Reserve cautious about cutting interest rates, according to FactSet data. Despite this, traders in the federal-funds futures market on Monday saw a 93.6% probability that the Fed will start cutting its benchmark rate in September, based on the CME FedWatch Tool. However, policymakers will review upcoming inflation data before making a decision. U.S. stocks closed higher on Monday, led by the “Magnificent Seven” and chip stocks like Nvidia, which rose by 4.76% after a challenging week. The Nasdaq Composite increased by 1.6%, the S&P 500 by 1.1%, and the Dow Jones Industrial Average edged up by 0.3%, according to FactSet data.