Less optimistic projections raise fears about the US$ 15 trillion valuation of big tech

(Bloomberg) – Investors are entering another cycle of decisive results from big technology companies, whose shares are close to historic highs and elevated valuations. An important distinction this time around: The group’s earnings growth is projected to be the slowest in nearly two years.

Shares of Alphabet (), the parent company of Google, Meta (), Instagram, Facebook and WhatsApp, and other technology giants rose at the beginning of the year, outperforming the market amid a climate of greater risk appetite and high expectations in in relation to the billions of dollars that companies are spending to develop artificial intelligence services.

However, the earnings release period starting this week could be discouraging for stock market optimists: while profits from the so-called Magnificent Seven (the seven largest technology companies in the United States) continue to grow — and vastly outpace the rest of the market — Wall Street anticipates a sharp slowdown in growth compared to previous quarters. What is understood is that pressure is increasing on this group, which has driven an increase of around US$15 trillion in the Nasdaq 100 Index since the end of 2022.

“This should be a pretty good earnings season, but the bar has been raised and they may not be able to meet high expectations,” said Dan Taylor, chief investment officer at Man Numeric. “It will be very difficult for the group to perform like last year, especially as ratings have increased.”

The announcements from the seven companies begin next Wednesday (29), when Microsoft, Meta and Tesla () are going to release their results. Apple () follows on Thursday (30), while Alphabet and Amazon () will announce next week, and then chipmaker Nvidia on February 26.

The sector’s superior earnings growth and excitement around AI have been key drivers for U.S. stocks during the bull market that began more than two years ago. Large-cap technology companies accounted for most of the S&P 500’s roughly 70% gain over that period, but gains have slowed amid weaker earnings expectations and questions about when all the AI ​​investments will start delivering returns. more significant.

Smaller growths

Profits for the seven giants are projected to rise 22% in the fourth quarter from a year earlier, the smallest increase since the first quarter of 2023, data compiled by Bloomberg Intelligence show. While this is still well above the 8% increase expected for the S&P 500 Index, it is a drop from the 51% increase seen in the first quarter and is declining for the fourth consecutive quarter.

Michael Casper of Bloomberg Intelligence sees reason for concern. With the technology sector’s share of the S&P 500’s market value exceeding its share of profits by about 10 percentage points, the equity strategist worries that either earnings growth needs to improve or valuations need to fall.

“We know how stocks react if they don’t achieve what everyone expects of them,” Casper said.

When looking at prices relative to projected sales, valuations look even more precarious. With nearly eight times projected revenue for the next 12 months, the S&P 500 Information Technology Index is trading near its highest in at least a decade, according to BI data.

Still, for Solita Marcelli, chief investment officer for the Americas at UBS Global Wealth Management, the valuations are worth it, with AI investments expected to generate more revenue next year.

“While the easy gains from AI may be behind us, we believe this rally is far from over,” she wrote in a note to clients this month.

Projections point to a combined spending of more than US$200 billion by Microsoft, Alphabet, Amazon and Meta on capital expenditures in the last fiscal year, and all have promised to spend more in the current year. In addition to growth in AI-related revenue, investors will be monitoring spending forecasts.

There are few signs that stock traders are prepared for a major disappointment. Demand for downside-protecting puts relative to demand for calls on Magnificent Seven shares is declining after a peak in December.

So far, optimists have been rewarded. Netflix, one of the few technology companies to have released results, helped boost the Nasdaq 100 last week after reporting a record increase in subscribers.

“Valuations may be stretched, and there may be some disappointment around the monetization of AI,” said Man Numeric’s Taylor, but big tech companies “remain big businesses generating a ton of cash.”

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