Technology stocks have been on a tear over the past month, but behind the scenes the big picture for the sector’s profits has only gotten darker.
Analyst estimates for 2022 profit growth at S&P 500 tech companies have fallen about two percentage points since second-quarter earnings reports kicked off in July, according to data compiled by Bloomberg Intelligence. The decline has been even greater for 2023 projections, as Wall Street braces for a potential recession and slower revenue growth.
At a time when the Federal Reserve is still aggressively hiking interest rates and inflation remains high, the deteriorating profit outlook is making many investors skeptical that the furious rally in the Nasdaq 100 Index is sustainable.
“It’s highly illogical what’s going on right now,” said Mike Mullaney, director of global market research at Boston Partners. “If you look at the underlying facts, it doesn’t make a lot of sense.”
The Nasdaq 100 has gained 19% since closing at a nearly two-year low on June 16 as of the end of last week. The rally has been fueled by better-than-feared results from megacaps like Microsoft Corp., a decline in US Treasury yields and speculation that the economy may be able to skirt a recession. Technology stocks had simply fallen further than could be justified by fundamentals, bulls contend.
Apple Inc. has gained 27% from the June low and sits less than 10% below the stock’s January record. Amazon.com Inc. has rallied back 36% and is threatening to overtake Alphabet Inc. in market value.
With estimates falling and stocks rising, the S&P 500 technology sector’s price-to-projected earnings ratio now sits more than 20% above the average for the index, according to Bloomberg Intelligence strategists Gina Martin Adams and Michael Casper.
“Even an average premium is tough to justify with rising rates, negative estimate revisions and earnings expected to trail the market” until at least the second half of 2023, they wrote in a research note last week.
For Mark Haefele, chief investment officer at UBS Global Wealth Management, while the rally is encouraging, it’s too soon to aggressively move back into growth stocks.
“With near-term uncertainty around inflation, Fed policy, and global growth, we continue to favor investing in value with a quality tilt,” he said.