There’s growing concern on Wall Street that the current surge in tech stocks may be coming to an end. This was evident on Thursday when the Nasdaq 100 Index, which is heavily weighted toward technology companies, experienced its biggest drop in five months following disappointing earnings reports from Netflix and Tesla. These results have dampened the outlook for the tech sector, especially as strong employment data suggests that the Federal Reserve may not be ending its aggressive monetary policy tightening anytime soon.
Next week, around 170 companies in the S&P 500 Index, representing 40% of its market capitalization, are set to release their earnings reports. This includes tech giants such as Microsoft, Meta Platforms, and Alphabet. In addition, after the Fed announces its latest decision on interest rates on Wednesday, investors will be looking for clues from Chair Jerome Powell on whether the expected quarter-point rate hike will be the last.
The main concern for investors in the second half of the year is the Federal Reserve. If the Fed raises rates more than anticipated, it could have a negative impact on tech and growth stocks. The high valuations of these stocks are particularly sensitive to interest rates, as they are based on future earnings and cash flows. Tech stocks have rallied this year due to their resilient profits and the Fed’s slower rate hikes, but with valuations already lofty, there is a need for them to come down.
The Nasdaq 100 Index has surged 42% this year and currently trades at 29 times forward earnings. Despite the recent drop, the index is still poised to end the week only slightly lower. The performance of big tech companies is crucial to the broader market, as they have the heaviest weighting in the S&P 500 index. Apple, Microsoft, Amazon, Nvidia, and Alphabet have a combined forward price-to-earnings ratio of 30, which is the highest since March 2022.
However, there are expectations that the top five S&P 500 companies will continue to improve their earnings, thanks to their aggressive cost-cutting efforts. Analysts forecast a 16% profit expansion in the second quarter for these companies, compared to a 9% earnings contraction for the rest of the index. Additionally, if producer-price inflation eases further, it could bolster profit margins in the second half of the year and support equity prices more broadly.
Despite the positive outlook for earnings, some investors are concerned that tech stocks have become overvalued, drawing comparisons to the dot-com bubble. The rapid rise in tech stocks this year has led to fears of missing out on potential gains. However, investors are reminded of the risks involved, as seen during the turn of the millennium when hype and speculation resulted in significant losses.
In conclusion, the tech-stock surge is facing potential headwinds due to disappointing earnings reports and concerns about the Federal Reserve’s monetary policy tightening. The upcoming earnings releases from tech bellwethers and the Fed’s decision on interest rates will provide further clarity on the sector’s outlook. While there are expectations of continued earnings growth among big tech companies, caution is advised as valuations remain high. Investors must carefully consider the risks and potential rewards associated with the tech sector’s performance.
