There is more evidence that the economy is slowing, with some leading indicators at the levels generally associated with a recession. At the same time, the S&P 500 is trading at valuation multiples historically associated with bubble.

Thus, if the stock market is in a bubble, and we are facing a recession, then investors should prepare for a bubble burst and a recessionary bear market - a major drawdown.

The stock market bubble is concentrated in several mega-cap tech companies, known as the Magnificent 7. Despite the obviously slowing economy, these mega-cap stocks keep climbing under the Gen AI theme, pushing the S&P 500 index into new highs.

This mega-cap bubble is likely to burst only when the mega caps disappoint on their earnings report, either missing the earnings/sales estimates, or providing weak guidance. In fact, the dot-com bubble burst in March of 2000 with the weak Yahoo earnings report.

The current situation is very similar to March 2000 - the economy is slipping into a recession, and the monetary policy is tight, while the stock market is in a bubble. The key question then is whether the mega-cap bubble stocks will disappoint during the upcoming Q2 2024 earnings season, like in March of 2000.

In my opinion, the slowing economy is likely to be reflected in the corporate earnings reports in Q2 2024. Thus, there is a high chance that we could see a major miss in the earnings by one of the mega-caps, which could burst the bubble.

The big picture on earnings estimates

The bottom-up analyst earnings estimate for Q2 2024 for the S&P 500 is 8.1% earnings growth YoY, and 9.2% YoY earnings growth for 2024, as shown on the CFRA table presented below.

More importantly, analysis predicts 14.6% earnings growth YoY for 2025.

For 2024, the earnings growth is concentrated in Information Technology, Communication Services, and Consumer Discretionary sectors, which include the Mag 7 stocks. However, accelerated earnings growth is expected across all sectors in 2025, including the value and small stocks.

Thus, analysts are very optimistic on Mag 7 stocks in 2024, and see a major earnings growth broadening in 2025, which can only be justified with accelerated economic growth in 2025.

Yet, the economy is currently sharply slowing, and we could already be in a recession based on some key indicators, like the Sahm Indicator. Thus, obviously, the earnings estimates are unrealistic for 2024 and 2025 - they don't even assume a minor slowdown. So, that's part of the bubble - unrealistic earnings expectations.

Thus, in my opinion, the mega-caps are likely to start feeling the current economic slowdown and, consequently lower their earnings guidance, which is likely to burst the bubble.

The Mag 7 themes

So, let's look at the situation with each Mag 7 stock since the Q1 2024 earnings report. First, the S&P 500 (SP500) increased by 7% over the last 3 months, since the beginning of the Q1 2024 earnings season.

However, over the last 3 months, only 231 of S&P 500 stocks went up, while 272 went down. Also, the equal weighted S&P 500 (RSP) is actually down by -1.63% over the last 3 months.

Thus, the Mag 7 stocks are leading the index higher, while most stocks are actually going down.

Here is the theme behind each Mag 7 stock.

• NVIDIA (NVDA) is up by 43% over the last 3 months, and since the last earnings report it spiked higher due to the 10-1 stock split, which attracted heavy interest from the retail investors. Nvidia is not going to announce another stock-split in Q2, but it will likely report QoQ sales growth in single digits, which is simply not enough to justify the lofty PE ratio of 74. Thus, NVDA is likely to fall after the Q2 earnings, unless it reveals a major stock buyback.
• Apple (AAPL) is up by 34% over the last 3 months, despite quarterly revenue being down 4% YoY. Apple spiked likely due to the $110B additional share repurchase, and anticipated release of Apple Intelligence. Apple now must guide that the I-phone replacement cycle will be massive due to the AI upgrade; otherwise the stock is likely to drop sharply after the earnings release, given the PE ratio of 36.
• Tesla (TSLA) is up by 53% over the last 3 months, despite missing on earnings are revenues in Q1 because the company refocused to an AI robotics company. Given the PE ratio of 65, TSLA is likely to drop after the Q2 earnings report, as robo-taxies are still just a "story", and the decrease in EV demand will start affecting the balance sheet health.
• Alphabet (GOOG) (GOOGL), also revealed an additional $70B in stock repurchase and initiated dividends in Q2, and the stock spiked by 25% over the last 3 months. Alphabet will have to keep rising guidance for the cloud business, but the slowing economy could start affecting the ad business, which could result in a miss, and the stock drop.
• Amazon (AMZN) stock increased modestly by 8% over the last 3 months, with a lofty PE ratio of 56. Amazon will have to keep rising guidance for the AWS cloud business, but the slowing economy could start affecting the retail business, which could result in a miss.
• Meta (META) already provided weak guidance for Q2, and the stock dropped by 12% after the earnings report. However, the stock bounced back to rise by 2% over the last 3 months in sympathy with other mega caps. Meta has heavy AI capex, and investors will watch the ad revenue to see evidence of AI monetization. However, a slowing economy is likely to affect the ad revenues, and Meta is likely to miss guidance expectations again.
• Microsoft (MSFT) is also all about the cloud revenue growth and Gen AI Capex. Over the last 3 months, the stock went up by 10%, but the PE ratio is very expensive at 41. A slowing economy could start affecting Microsoft sales in other sectors.

Stock	Last 3 months	PE ratio GAAP ttm
NVDA	+43%	74
AAPL	+34%	36
TSLA	+53%	65
GOOG	+25%	29
META	+2.38%	31
AMZN	+8%	56
MSFT	+10%	41

Implications

The Mag 7 stocks have been leading the S&P 500 higher over the last 3 months. However, the move has been driven by speculative non-fundamental themes, such as stock splits, and buybacks.

In my opinion, Meta is an example of what's coming to the rest of the Mag 7 stocks - Meta missed the guidance for Q2, and it's likely some other Mag 7 stocks will miss the guidance for Q3.

A slowing economy is a systematic event, and it will have to start affecting the business operations of the Mag 7 companies. Thus, the non-realistic earnings expectations will have to meet the reality, and it could happen during the Q2 earnings season.

Given the importance of the Mag 7, the S&P 500 (SP500) is likely to sharply drop as the Mag 7 bubble bursts.