Microsoft kicks off high-risk tech earnings season

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, which kicks off the group’s reporting on Tuesday, joined in starting to cut thousands of jobs this week as sales slow. Google parent Alphabet 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. 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,” said Michael Casper, an equity strategist with Bloomberg Intelligence. “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.”

Firms including Texas Instruments, Lam Research and Intel also report next week. Apple, Alphabet and other behemoths announce the week after. The group has huge sway over the path of the overall market, with infotech accounting for more than 25% of the S&P 500’s market capitalisation.

Fourth-quarter earnings for tech firms in the benchmark are projected to drop 9.2% from the same period a year earlier, the steepest slide since 2016. The speed of the deterioration in sentiment is notable: three months ago, Wall Street merely saw profits coming in flat.

Fading growth

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 PCs 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% tumble in the Nasdaq 100. The gauge is priced at about 21 times profits projected over the next 12 months, compared to an average of 20.5x for the past decade, and further estimate cuts would only make it look more expensive. The multiple bottomed at 17.7x in 2020 and at 11.3x in 2011, in the wake of the recession that ended in 2009.

Still, for Sameer Bhasin, principal at Value Point Capital, 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.”

Monetary policy has a lag and we’re likely still in the window of that. We haven’t seen the earnings impact you’d expect to see from rate hikes

Analysts anticipate that tech profits will return to growth in the second half of the year. 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, says Nick Getaz, a portfolio manager of the Franklin Rising Dividends Fund.

“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.”  — Jeran Wittenstein, with Ryan Vlastelica, (c) 2023 Bloomberg LP

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