There’s growing concern on Wall Street that the twin engines of this year’s tech-stock surge are at risk of sputtering.
That was evident Thursday, when the technology-heavy Nasdaq 100 Index dropped by the most in five months as disappointing earnings reports from Netflix Inc. and Tesla Inc. dampened the outlook for the sector. At the same time, strong employment data underscored worries that the Federal Reserve may not be on the verge of ending its most aggressive monetary policy tightening in decades.
And bigger tests are coming soon.
Next week, around 170 companies in the S&P 500 Index, representing 40% of its market capitalization, are set to post results, including tech bellwethers Microsoft Corp., Meta Platforms Inc. and Google parent Alphabet Inc. And on Wednesday, after the Fed announces its latest decision on interest rates, Chair Jerome Powell will provide clues on whether investors were correct to wager that its expected quarter-point rate hike will be its last.
“The number one concern for investors in the second half of the year is all about the Fed,” said Eric Diton, president and managing director of Wealth Alliance. “If there are more hikes than Wall Street expects, it will be bad for tech and growth stocks. Valuations need to come down.”
Growth stocks are highly sensitive to interest rates, which are used to calculate what earnings in the years ahead are worth right now. Tech has rallied this year as its profits have proven to be resilient and the Fed started to slow down the pace of its rate hikes, even keeping them steady at the last meeting.
After this year’s advance, spurred in part by excitement over artificial-intelligence breakthroughs, valuations have gotten lofty. The Nasdaq 100 has soared 42% this year, and it is trading at 29 times forward earnings. And the gains keep coming - even after posting its worst day in months on Thursday, the index is poised to end the week only slightly lower.
Big tech is also crucial to the S&P 500 index, since the companies’ large market values give them the heaviest weighting in the benchmark. The five biggest firms in the index — Apple, Microsoft Amazon.com Inc., Nvidia Corp. and Alphabet — trade at a combined 30 times forward earnings, the highest since March 2022, according to data compiled by Bloomberg Intelligence. That’s nearly twice the multiple for the rest of the index.
Of course, some of that also reflects expectations that big-tech earnings will continue to improve after the companies’ aggressive cost-cutting efforts. In fact, those top five S&P 500 corporations are forecast to show a 16% profit expansion in the second quarter, according to BI. That compares with a 9% earnings contraction for the broader equities gauge.
Read more: Nvidia-Led AI Rally Leaves Little ‘Room for Error’ in Earnings
Other signals bode well for profits in the second half of the year, particularly if easing producer-price inflation keeps bolstering margins, said Gina Martin Adams, chief equity strategist at BI.
“No one is talking about the potential for earnings pressures to continue to ease for the top five companies in the S&P 500,” she said. “That could actually resolve itself, with the rest of the index playing catchup with improving profits. That would ultimately help support equity prices more broadly.”
Microsoft, which is scheduled to report earnings on July 25, raised hopes that AI-advances will start paying off after it announced that its pricing of corporate applications was higher than many investors were expecting.
Yet the steep run up so far this year has made some investors concerned that the stock-market’s expectations have run too far, drawing some comparisons with the buildup to the dot-com crash.
“The tech ‘FOMO’ worries me in the coming months,” said Cheryl Smith, portfolio manager and economist at Trillium Asset Management. “If you look back at the turn of the millennium, the internet certainty transformed our lives, but in 1999 investors could have lost a lot of money getting caught up in the hype betting on them, so you have to be careful.”