Investors Await Tech Earnings in Next Test for Markets

Tech stocks are off to a strong start after enduring a miserable 2022. The first big rally test of the new year is on tap.

Even after selling sharply, the five largest US companies— Apple Inc.,

Microsoft corp.

Alphabet Inc.,

Amazon.com Inc.

and Berkshire Hathaway Inc.

—accounts for 18.9% of the S & P 500. This is well above the historical average of about 15%, according to S & P Dow Jones Indices.

The heavy weighting of companies in the index makes the next round of quarterly earnings especially important because any disappointment could leave the broader market vulnerable to a sell-off. Microsoft reported sales of $52.7 billion and net income of $16.4 billion on Tuesday afternoon, and other companies will follow in February.

“You care about these earnings even if you don’t,” said Daniel Morgan, senior portfolio manager at Synovus Trust.

Expectations for the group are not high. Microsoft’s sales grew by 2% and its profit fell by 12% from a year ago. Analysts expect revenue growth of just 2% on average at the other three major tech companies this quarter, including a 1% decline at Apple. Profits are expected to decline at all three companies by an average of 39%, according to FactSet..

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The pandemic has fueled a sales boom in everything from iPhones to cloud-computing contracts, sending stock prices soaring. Silicon Valley giants rushed to hire enough workers to keep up with rising demand.

But last year, the script flipped when the Federal Reserve embarked on its campaign to tighten monetary policy. Fears of a possible recession grew just as the pandemic-era boom ended. Now, the prospect of tighter regulation also looms on the horizon.

“In this type of environment, companies are looking to limit costs, so some IT costs are likely to be recovered,” said Michael Walker, portfolio manager at AllianceBernstein..

His fund owns shares of Microsoft and Amazon.

Tech companies are cutting staff sharply after their headcount swelled in the pandemic boom. Alphabet said last week it plans to cut 12,000 jobs, its biggest layoff ever. Microsoft said last week it was cutting 10,000 jobs, its biggest round in eight years. Amazon.com and Facebook parent Meta platform Inc.

they also cut thousands of jobs. Executives are sounding a harsher tone.

“We will go into a phase today where there will be a normalization of demand,” Microsoft Chief Executive Satya Nadella said last week. “We in the tech industry are going to have to be more efficient—it’s not about everyone else doing more and less, we’re going to have to do more and less. We will have to show our own productivity gains.”

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Early returns so far this year are encouraging. Alphabet’s stock gained 11%, while Amazon and Meta gained about 15% and 19%, respectively. Apple increased 9.7%, while Microsoft stock is up about 1%. Still, these stocks are well below their record highs, despite the recent rally.

The sector benefited from hopes that the Fed will soon reverse course on its tightening campaign. The 10-year Treasury yield recently closed at its lowest level since September. Technology stocks have historically done well when bond yields are low.

In addition, the dollar has weakened significantly of late, after the strength of the currency hindered companies with large overseas operations last year. The WSJ Dollar Index closed Tuesday at 95.09, down nearly 10% from last year’s peak in September.

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Ryan Grabinski, investment strategist at Strategas Research Partners, said the heavy weighting of technology stocks presents a new risk for index funds in a weaker operating environment. “These top stocks have carried the weight of earnings for years,” referring to their share of profits that match their share of market value.

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He added that the technology sector accounted for 26% of the S&P 500’s market value at the end of 2022, but contributed just 21% of earnings in the most recent 12 months.

“The risk now is that some of these business lines will not earn what they earned,” Mr. Grabinski said.

The tech earnings season started on a positive note. Netflix Inc.

shares rose last week after reporting results that topped Wall Street analysts’ forecasts. The company exceeded its own subscriber growth forecasts and said it would crack down on password sharing and launch an ad-supported plan.

Additionally, tech stocks look more attractive after the steep selloff. Microsoft and Apple, for example, trade at less than 26 times and 23 times last earnings, respectively. Both stocks are trading above 40 times earnings in 2021, according to FactSet.

Bulls still see the business slowdown as a short-term problem for an otherwise attractive investment.

“I don’t see the total erasure of the group like in 2000,” said Mr. Morgan. “We may be entering a mild recession, but many of these technologies are here to stay and are proven.”

Write to Charley Grant at [email protected]

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