(Bloomberg) - Investors are heading into yet another pivotal Big Tech earnings cycle with the companies’ shares near record highs and valuations stretched. A key distinction this time: The group’s profit growth is projected to come in at the slowest pace in almost two years.
Shares of Alphabet Inc. (GOOG), Meta Platforms Inc (META). and other technology giants have rallied to start the year, outperforming the broader market amid a risk-on mood and high hopes for the billions of dollars the companies are spending to develop artificial-intelligence services.
But the reporting period that kicks off this week may prove sobering for equities bulls: While earnings from the so-called Magnificent Seven behemoths are still rising — and far outpacing the rest of the market — Wall Street anticipates a marked slowdown in growth relative to prior quarters. What it comes down to is that pressure is mounting on the cohort, which has driven a roughly $15 trillion rally in the Nasdaq 100 Index since the end of 2022.
“This should be a fairly good earnings season, but the bar has been raised and they may not be able to live up to high expectations,” said Dan Taylor, chief investment officer at Man Numeric. “It will be very difficult for the group to perform the way it did last year, especially as valuations have increased.”
The seven companies’ announcements start Wednesday, when Microsoft Corp (MSFT)., Meta and Tesla Inc. (TSLA) are scheduled to report. Apple Inc (AAPL). follows Thursday, while Alphabet and Amazon.com Inc. (AMZN) announce next week, and then chipmaker Nvidia Corp (NVDA). on Feb. 26.
The sector’s superior earnings growth and exuberance around AI have been key drivers for US stocks during the bull market that began more than two years ago. The megacap tech companies have accounted for the bulk of the S&P 500’s roughly 70% advance in that period, but gains have slowed amid expectations for weaker profits and questions about when all the AI investments will pay off more meaningfully.
Smaller Jump
Profits for the seven giants are projected to increase by 22% in the fourth quarter from a year earlier, the smallest jump since the first quarter of 2023, data compiled by Bloomberg Intelligence show. While that’s still well above the 8% increase anticipated for the S&P 500 Index (^SPX), it’s down from the 51% increase seen in the first quarter and shrinking for a fourth straight quarter.
Bloomberg Intelligence’s Michael Casper sees cause for concern. With the tech sector’s share of the S&P 500’s market value eclipsing its share of profits by about 10 percentage points, the equity strategist worries that either earnings growth has to improve or valuations need to drop.
“We know how stocks react if they miss on what everyone wants them to hit,” Casper said.
When looking at prices relative to anticipated sales, valuations look even more precarious. At nearly eight times revenue projected over the next 12 months, the S&P 500 Information Technology Index trades close to the highest in at least a decade, according to BI data.
Still, to Solita Marcelli, chief investment officer Americas at UBS Global Wealth Management, the valuations are worth paying up for with AI investments expected to generate more revenue in the year ahead.
“While the easy gains in AI may be behind us, we think this rally looks far from over,” she wrote in a note to clients this month.
Microsoft, Alphabet, Amazon and Meta are projected to have spent more than $200 billion combined on capital expenditures in their last fiscal year, and they’ve all pledged to spend more in the current year. In addition to growth in AI-related revenue, investors will be monitoring spending forecasts.
There are few signs that traders are primed for a massive disappointment. Demand for put options that protect against downside moves versus demand for call options in the Magnificent Seven stocks is shrinking after a spike in December.
So far, bulls have been rewarded. Netflix Inc., one of the few tech-related companies that have reported, helped boost the Nasdaq 100 last week after posting a record jump in subscribers.
“Valuations may be extended, and there could be some disappointment over the monetization of AI,” said Man Numeric’s Taylor, but big tech firms “remain great businesses throwing off a ton of cash.”
By Jeran Wittenstein and Ryan Vlastelica
With assistance from Natalia Kniazhevich
