US technology stocks are about to hit their next hurdle when earnings season for the most influential segment of the S&P 500 Index gets under way in the coming week: vanishing profits.
The tech-heavy NASDAQ 100 Stock Index enters this crucial stretch amid a darkening backdrop that short-circuited a strong start to the year. Underscoring the risks ahead, Microsoft Corp, which begins the group’s reporting tomorrow, joined Amazon.com Inc in starting to cut thousands of jobs last week as sales slow. Google parent Alphabet Inc followed with plans of its own to shrink its workforce.
Wall Street has been slashing earnings estimates for months for the tech sector, which is projected to be the biggest drag on S&P 500 profits in the fourth quarter, data compiled by Bloomberg Intelligence show. The danger for investors, however, is that analysts still prove too optimistic, with demand for the industry’s products crumbling as the economy cools.
“Tech is driving a lot of the overall earnings recession that we’re seeing in the S&P,” Bloomberg Intelligence equity strategist Michael Casper said. “While there’s a lot baked in, depending on if this recession does emerge and how badly it occurs, there is certainly some negative revision risk for the sector still.”
BEHEMOTH REPORTS
Firms including Texas Instruments Inc, Lam Research Corp and Intel Corp also report earnings this week. Apple Inc, Alphabet and other behemoths are to announce their results next week. The tech group has huge sway over the path of the overall market, with info-tech accounting for more than 25 percent of the S&P 500’s market capitalization.
Fourth-quarter earnings for tech firms in the benchmark are projected to drop 9.2 percent from the same period a year earlier, the steepest slide since 2016, data compiled by Bloomberg Intelligence show. The speed of the deterioration in sentiment is notable: Three months ago, Wall Street merely saw profits coming in flat.
Revenue growth for these companies is fading relative to the past couple of years, when the pandemic and ensuing lockdowns supercharged sales for everything from digital services to personal computers and the components that power them. Higher costs are also squeezing profits.
The concern, however, is that valuations are still far from cheap despite last year’s 33 percent tumble in the NASDAQ 100. The gauge is priced at about 21 times profits projected over the next 12 months, compared with an average of 20.5 for the past decade, and further estimate cuts would only make it look more expensive. The multiple bottomed at 17.7 in 2020 and at 11.3 in 2011, in the wake of the recession that ended in 2009.
BAD NEWS PRICED IN
Still, for Value Point Capital principal Sameer Bhasin most of the bad news has been priced in. He anticipates that first-quarter profit estimates may have further to fall, but says some of the fears are overblown.
“Tech isn’t suffering from an industry demand issue, it’s suffering more from a digestion of the excesses that were built in during the pandemic,” he said. “There’s money on the sidelines that is waiting to be put back into the sector.”
Analysts anticipate that tech profits will return to growth in the second half of the year, data compiled by Bloomberg Intelligence show. That will make executives’ outlooks for the full year all the more critical for stocks.
As earnings roll in over the next few weeks, investors will have plenty of risks to monitor.
Among them are the possibility that inflation proves to be more entrenched than many expect, as well as the effect of higher rates on profits, Franklin Rising Dividends Fund portfolio manager Nick Getaz said.
“Monetary policy has a lag and we’re likely still in the window of that,” he said. “We haven’t seen the earnings impact you’d expect to see from rate hikes.”
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