Concerns are growing on Wall Street that the tech-stock surge of 2023 might be at risk of slowing down. This worry was evident on Thursday when the Nasdaq 100 Index, which is heavily weighted towards technology stocks, experienced its biggest drop in the past five months. Disappointing earnings reports from key tech players Netflix and Tesla dampened the sector’s outlook. Additionally, strong employment data increased worries that the Federal Reserve may not be close to ending its aggressive monetary policy tightening.
Investors are bracing themselves for more potential challenges in the coming week. About 170 companies in the S&P 500 Index, representing 40% of its market capitalization, are scheduled to release their earnings reports, including industry leaders Microsoft, Meta Platforms, and Alphabet. Furthermore, after the Federal Reserve announces its latest decision on interest rates, Chair Jerome Powell will provide clues about whether investors were accurate in their assessment that the expected quarter-point rate hike will be the last one.
Eric Diton, President and Managing Director of Wealth Alliance, believes that the number one concern for investors in the second half of the year is all about the Fed. If there are more rate hikes than anticipated, it could have a negative impact on the tech and growth stocks, leading to the need for valuations to decrease.
Tech stocks are especially sensitive to interest rates since they affect the calculation of the present value of future earnings. Despite an impressive rally this year driven by excitement over advancements in artificial intelligence, valuations have reached lofty levels. The Nasdaq 100 has surged by 42% thus far in 2023 and is currently trading at 29 times forward earnings. Interestingly, even after experiencing its worst day in months on Thursday, the index is poised to end the week only slightly lower.
The dominance of big tech companies in the S&P 500 index is also a crucial factor. These companies, such as Apple, Microsoft, Amazon.com, Nvidia, and Alphabet, have the heaviest weighting in the benchmark. Together, they trade at a combined 30 times forward earnings, the highest since March 2022. This is nearly twice the multiple for the rest of the index.
Nevertheless, expectations for big-tech earnings to continue improving after their aggressive cost-cutting efforts have contributed to these valuations. According to Bloomberg Intelligence, the top five S&P 500 companies are forecasted to show a 16% profit expansion in the second quarter, while the broader equities gauge is expected to experience a 9% earnings contraction.
Gina Martin Adams, Chief Equity Strategist at Bloomberg Intelligence, believes that there are other positive signals for profits in the second half of the year. If producer-price inflation continues to ease, it could help bolster profit margins. Adams suggests that there is little discussion about the potential for earnings pressures to ease for the top five companies in the S&P 500, and this could lead to improved profits throughout the rest of the index, supporting equity prices more broadly.
Microsoft, which is set to report its earnings on July 25, has heightened hopes that advancements in artificial intelligence will start to pay off, as indicated by higher than expected pricing of their corporate applications.
However, some investors are concerned about the substantial increase in tech stock expectations so far this year, drawing comparisons to the buildup to the dot-com crash. Cheryl Smith, Portfolio Manager and Economist at Trillium Asset Management, expresses concern about the tech FOMO (fear of missing out) in the coming months. While technology has undoubtedly transformed our lives, Smith warns investors to be cautious, highlighting the potential for significant losses in 1999 when investors got caught up in the hype surrounding the internet.
