With risk-free interest rates soaring and the US stock market in turmoil, can tech giants' earnings reports turn the tide?

Zhitong
2023.10.16 02:41
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Investors are hoping that the profit machines of large technology companies will support the earnings of the S&P 500 index.

As concerns about the US stock market seem to be increasing every day, investors hoping for good news during earnings season have pinned their hopes on a familiar group: Big Tech. After cutting thousands of jobs to reduce costs, the largest technology and internet companies in the US are generating high profits similar to those two years ago when the pandemic caused a surge in sales of digital services and electronic devices. The current expectation is that the performance of these tech giants will help offset the weakness in industries such as energy and healthcare, which are still mired in profit declines.

The five largest companies in the S&P 500 Index - Apple (AAPL.US), Microsoft (MSFT.US), Alphabet (GOOGL.US), Amazon (AMZN.US), and Nvidia (NVDA.US) - account for about a quarter of the market value of this benchmark index. Analysts estimate that the earnings of these companies are expected to grow an average of 34% compared to the same period last year. However, the overall outlook for the S&P 500 Index is not as strong. The earnings of the index's constituent stocks are expected to remain relatively flat, but without these five giants, they would face a decline of about 5%.

Gary Bradshaw, portfolio manager at Hodges Capital Management, a capital management company, said, "The performance of large-cap tech stocks is very important and can boost market confidence widely. Wall Street expects good earnings from all companies. Large-cap tech stocks have everything it takes to lead the market in the last quarter of this year."

Leading the Market

This month, market unease has been triggered by rising interest rates, with the yield on 10-year US Treasury bonds reaching its highest level in over a decade. A higher-than-expected inflation report has led investors to anticipate that the Federal Reserve will maintain its tightening policy and may raise interest rates again. Against this backdrop, concerns about a potential recession have resurfaced, exacerbated by the Israeli-Palestinian conflict. In the face of these unfavorable factors, US tech stocks have been struggling, with the tech-heavy Nasdaq 100 Index falling for two consecutive months. However, their performance still far exceeds the overall market. Of the 13% gain in the S&P 500 Index this year, these five major tech companies have contributed the majority.

Netflix (NFLX.US) and Tesla (TSLA.US) are scheduled to release their earnings reports on Wednesday. Alphabet, Microsoft, Amazon, and Meta Platforms (META.US) will announce their earnings reports next week. Apple will release its earnings report on November 2, and Nvidia will release its earnings report on November 21. FBB Capital Partners' research director, Mike Bailey, said that after a strong performance in the second quarter, "we need to see more of the same in the third quarter. Given their significant weight, you can bet that as the earnings of large tech companies are announced this quarter, other companies in the market will follow suit." He said he believes "the likelihood of a collapse in tech company profits this quarter is quite low." Investors seem to have good reason to remain optimistic. Data shows that the S&P 500 index has risen during earnings seasons about two-thirds of the time over the past century.

Potential Obstacles

One potential obstacle to the rise of the US stock market driven by earnings reports is that many anticipated positive news may already be priced into the stock prices. Alphabet and Amazon have seen gains of over 50% this year, while Apple and Microsoft have seen gains of nearly 40%. In addition to rising profit expectations, these stocks have also benefited from the belief that tech giants are best positioned to capitalize on the generation of artificial intelligence. Despite NVIDIA's stock price doubling this year, it is the only company to have received a significant financial boost from this trend.

One reason investors are concerned is that even with recent stock price declines, the market valuations of large tech companies remain high. Apple and Microsoft have price-to-earnings ratios of around 27 and 29, respectively, well above the average levels of the past 10 years. This figure is around 18 times the overall price-to-earnings ratio of the S&P 500 index.

Kim Forrest, founder and chief investment officer of Bokeh Capital Partners, said that expensive stock prices put pressure on companies to achieve strong profits. In an interview, she said, "They must continually deliver on their promises, otherwise they will lose the attention of investors. Someone needs to continue buying, and these high valuations need to be proven."