Big Tech rules profit growth even as S&P leadership widens
BETS on the US stock market rally broadening out beyond a handful of tech behemoths this year are bumping into a familiar reality: Those same mega-caps remain Corporate America’s most likely source of profit growth.
Tech’s fourth-quarter earnings season kicks off this week with results from Netflix, Tesla and Intel. The so-called Magnificent Seven are expected to deliver combined profit growth of about 46 per cent, according to data compiled by Bloomberg Intelligence. That is down slightly from the third quarter’s 53 per cent expansion, but it still dwarfs almost all the main sectors in the S&P 500.
Considering how important these companies are to the overall stock market – they accounted for virtually all of last year’s 24 per cent advance and drove the S&P 500 to an all-time high last Friday (Jan 19) – earnings season does not quite get going until they show up with their results.
“The dominant growth in the market is coming from Big Tech,” said Anthony Saglimbene, chief market strategist at Ameriprise Financial. “If they disappoint, that’s a real risk to the overall market.”
Bulls are banking on strong earnings reports to rekindle a rally in the S&P 500 that has slowed a bit to start the year after 2023’s torrid pace. Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms accounted for about two-thirds of that gain.
Apple, one of the pillars of last year’s rally after adding nearly US$1 trillion in market value, has limped out of the gate in 2024 amid concerns about its growth prospects. Its most innovative product in years, the US$3,499 Vision Pro headset, is set to begin shipping next month but is unlikely to provide a jolt to sales any time soon.
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Meanwhile, Microsoft has pushed deeper into record territory on rising expectations that its expanding line-up of software infused with artificial intelligence (AI) software will fuel bigger profits. The Redmond, Washington-based company said on Jan 15 it will charge US$20 a month for a consumer version of its AI assistant.
Changing leadership
Looking at the stock market as a whole, the S&P 500 has had a bumpy ride to start the year, falling in early January before rising to a new record high last Friday. Investors are trying to assess the strength of the US economy and determine when the US Federal Reserve will start cutting its benchmark interest rate, which is sitting at the highest since the dot-com era.
The S&P 500’s leadership has changed in recent weeks, with Advanced Micro Devices, Broadcom, Eli Lilly and Merck among the most prominent point gainers so far in 2024. Meanwhile, Tesla, which is down more than 15 per cent since New Year’s, has become the heaviest drag on the S&P, with Apple close behind.
For tech investors, one big question is how much the AI craze will contribute to earnings and then spill over into stock prices. Nvidia, which is the best stock in the S&P 500 this year and last, dominates the market for chips used in AI computing. It is expected to post fourth-quarter profits of more than US$10 billion, up from US$1.4 billion a year ago.
Without Nvidia, the S&P 500 Information Technology Index’s projected fourth quarter profit growth would be more than cut in half, said Wendy Soong, an analyst with Bloomberg Intelligence.
Solita Marcelli, chief investment officer for the Americas at UBS Global Wealth Management, wrote on Jan 17: “We think more companies are likely to find ways to monetise their AI exposure, and investors will be looking for evidence on how companies can maintain or improve their margins.
“We are only in the first innings of the AI story.”
Crowding concerns
At the same time, signs of crowded positioning in tech are raising concerns about the risk of a sell-off if results from some of the giants disappoint. A global fund manager survey from the Bank of America this month showed the most common trade is being long Big Tech and other tech growth stocks.
To Matt Maley of Miller Tabak, recent trading has shown that Big Tech is driving the market again and the heavy concentration is a “warning flag” for investors that may come back to bite them.
“When the fast-money hedge funds have such large concentrated positions, it leaves the market very vulnerable to a short-term shock,” said Maley, the firm’s chief market strategist.
Despite this set up, the options market is pricing in “virtually no risk” for mega-cap stocks, said Brian Donlin, head of equity derivatives strategy at Stifel Nicolaus.
Ameriprise Financial’s Saglimbene is confident that any sell-off would be relatively short-lived, as the attraction of Big Tech stocks are unlikely to dim.
“Over the long term, investors will look to these companies and gravitate back to them because they really do have the growth, the recurring revenue and the potential for greater growth in the future,” he said. “No other sector offers that kind of runway for earnings.”
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