Earnings Continue to be a Risk for Technology Stocks

Pricey valuations and shrinking earnings estimates continue to be a hurdle for any rally in mega-cap technology stocks this year.  Even though price-earnings multiples have fallen from their pandemic peaks, many mega-cap tech stocks continue to look expensive.  Also, the profit outlook looks shaky as further rate hikes by the Fed may push the economy into recession. 

Moreover, there are risks for major technology companies other than just earnings.  For example, supply constraints and supply chain issues continue to affect Apple (AAPL), while weakness in online advertising has hurt the earnings outlooks for Alphabet (GOOGL) and Meta Platforms (META).  In addition, a slowdown in business spending could mean weaker trends for cloud computing, a key driver for earnings at Amazon.com (AMZN) and Microsoft (MSFT).

The convergence of a weak macroeconomic backdrop and shaky fundamentals suggests future corporate earnings could disappoint.  DataTrek Research said, “the fundamentals of the mega-cap technology companies are not improving, and at the margin, they’re deteriorating.”  While the Nasdaq 100 ($IUXX) (QQQ) slumped -33% last year, its biggest annual drop since 2008, it is up less than +1% this year, and Alphabet, Apple, and Microsoft are all lower on the year.

The markets remain concerned that upcoming Q4 earnings results, to be released later this month, could indicate fresh weakness in demand, a factor that has contributed to widespread layoffs at companies like Amazon.com, Meta Platforms and Salesforce Inc (CRM).  Data from Bloomberg Intelligence shows analysts expect tech-sector earnings to fall -2.2% this year, compared with growth of +2% for the overall S&P 500 ($SPX) (SPY).  The consensus for earnings has fallen dramatically over the past few months, with 2023 tech earnings forecasted as recently as September to rise 4.7%.

Estimated earnings for the S&P 500 technology sector are at 20.1 times estimated earnings, above the 10-year average of 18.9, and above the 17 multiple of the S&P 500 overall. If analysts cut their earnings estimates further for the tech sector, that would make the stocks appear pricier by lowering the denominator in the price-earnings ratio, potentially leading to more losses in stock prices.  Winslow Capital Management said that the market hadn’t yet priced in an earning recession and current “valuations are such that any bad news will be met with a selloff.” 

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