(Bloomberg) — U.S. technology stocks are about to hit their next hurdle as earnings season kicks off next week for the most influential segment of the S&P 500 index: disappearing profits.
Most read from Bloomberg
The technology-heavy Nasdaq 100 stock index is entering this crucial trajectory against a dark background that has hindered a strong start to the year. To underline the risks ahead, Microsoft Corp., which will begin group reporting Tuesday, has partnered with Amazon.com Inc. started cutting thousands of jobs this week as sales stagnate. Google parent Alphabet Inc. followed with its own plans to reduce the workforce.
Wall Street has been lowering earnings expectations for the technology sector for months, which is expected to be the biggest drag on S&P 500 earnings in the fourth quarter, data from Bloomberg Intelligence shows. The danger for investors, however, is that analysts continue to prove overly optimistic as demand for the sector’s products crumbles as the economy cools.
“Tech is driving much of the overall earnings recession we’re seeing in the S&P,” said Michael Casper, an equity strategist at Bloomberg Intelligence. “While there is a lot that is baked in, there is certainly still negative revision risk for the industry depending on whether this recession happens and how bad it happens.”
Companies like Texas Instruments Inc., Lam Research Corp. and Intel Corp. report next week as well. Apple Inc., Alphabet and other giants announce the following week. The group has tremendous influence over the path of the overall market, with infotech accounting for more than 25% of the S&P 500’s market cap.
Fourth-quarter earnings of benchmark technology companies are expected to fall 9.2% from the same period a year earlier, the steepest decline since 2016, data compiled by BI show. The speed of the deterioration in sentiment is remarkable: three months ago, Wall Street only saw earnings come in flat.
Sales growth for these companies is fading from recent years, when the pandemic and subsequent lockdowns boosted sales for everything from digital services to personal computers and the components that power them. Higher costs also reduce profits.
The concern, however, is that valuations are still far from cheap, despite last year’s 33% drop in the Nasdaq 100. The price of the meter is about 21 times expected earnings for the next 12 months, compared to an average of 20.5 for the past decade. , and further cuts would only make it look more expensive. The multiple bottomed out at 17.7 in 2020 and 11.3 in 2011, in the wake of the recession that ended in 2009.
Still, for Sameer Bhasin, director of Value Point Capital, most of the bad news has already been priced in. He expects earnings estimates for the first quarter to fall even further, but says some of the fears are overblown.
“Technology is not suffering from an industry demand problem, but more from a digestion of the excesses built in during the pandemic,” he said. “There is money on the sidelines waiting to be put back into the industry.”
Analysts expect tech earnings to grow again in the second half of the year, according to data compiled by BI. That makes managers’ full-year outlook all the more critical for equities.
As earnings roll in over the coming weeks, investors will need to keep an eye on a host of risks.
Among them are the possibility that inflation proves to be more entrenched than many expect, as well as the effect of higher rates on earnings, said Nick Getaz, a portfolio manager for the Franklin Rising Dividends Fund.
“Monetary policy is lagging and we are probably still in that phase,” he said. “We haven’t seen the earnings impact you would expect from rate hikes.”
Elsewhere in corporate earnings:
–With assistance from Ryan Vlastelica.
Most read from Bloomberg Businessweek
©2023 Bloomberg LP