Microsoft kicks off tech profits that will plunge the most since 2016

(Bloomberg Opinion) — U.S. technology stocks are about to hit their next hurdle when earnings season for the most influential segment of the S&P 500 Index kicks off next week: fading earnings.

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The tech-heavy Nasdaq 100 stock index enters this crucial stretch amid a dark backdrop that interrupted a strong start to the year. Underscoring the risks ahead, Microsoft Corp., which begins group reporting Tuesday, has joined Inc. in beginning cutting thousands of jobs this week due to slowing sales. Google parent Alphabet Inc. has followed through with its own plans to cut its workforce.

Wall Street has been cutting earnings estimates for months for the technology sector, which is expected to be the biggest drag on fourth-quarter earnings for the S&P 500, data compiled by Bloomberg Intelligence shows. The danger for investors, however, is that analysts are still too bullish, with demand for the industry’s products collapsing as the economy cools.

“Technology is driving a lot of the overall earnings downturn we’re seeing in the S&P,” said Michael Casper, an equity strategist at Bloomberg Intelligence. “While there’s a lot in the pipeline, depending on whether and how bad this recession kicks in, there’s certainly still a downside risk for the sector.”

Companies including Texas Instruments Inc., Lam Research Corp. and Intel Corp. also report next week. Apple Inc., Alphabet and other giants announce the following week. The group has great influence over the path of the broader market, with information technology accounting for more than 25% of the S&P 500 market capitalization.

Fourth-quarter earnings for tech companies in the benchmark index are projected to fall 9.2% from the same period a year earlier, the steepest drop since 2016, data compiled by BI shows. The speed of the deterioration in confidence is remarkable: three months ago, Wall Street simply saw flat gains.

Revenue growth for these companies is fading relative to the past two years, when the pandemic and subsequent lockdowns spurred sales of everything from digital services to personal computers and the components that power them. Higher costs are also reducing profits.

Valuation Concerns

The concern, however, is that valuations are still far from cheap despite last year’s 33% drop in the Nasdaq 100. The gauge is priced at roughly 21 times projected earnings for the next 12 months, in compared to an average of 20.5 over the past decade. , and further estimate cuts would only make it look more expensive. The multiple bottomed out at 17.7 in 2020 and 11.3 in 2011, following the recession that ended in 2009.

Still, for Sameer Bhasin, a director at Value Point Capital, most of the bad news has been discounted. He anticipates first-quarter earnings estimates may fall further, but says some of the fears are overblown.

“Technology is not suffering from an industry demand problem, it is suffering more from a digestion of the excesses that were incorporated during the pandemic,” he said. “There is money on the sidelines that is waiting to be reinvested in the sector.”

Analysts anticipate technology earnings to pick up again in the second half of the year, data compiled by BI shows. That will make the executives’ outlook for the full year even more critical for the stock.

As earnings rise in the coming weeks, investors will have plenty of risks to monitor.

Among them are the possibility that inflation turns out to be more entrenched than many expect, as well as the effect of higher rates on earnings, says Nick Getaz, portfolio manager of the Franklin Rising Dividends Fund.

“Monetary policy is behind schedule and we are probably still in the window of that,” he said. “We haven’t seen the earnings impact that you would expect to see from rate hikes.”

In other parts of corporate profits:

–With assistance from Ryan Vlastelica.

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