Investors Might Be Going Too Big On Big Tech

Investors Might Be Going Too Big On Big Tech

10 months ago4 mins

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Investors have been flocking to the Big Tech party, anticipating that rate cuts could result in the celebration of the year. But before you squeeze your way in, you’ll want to find out if the Big Tech fuss could turn out to be a flop.

🕰 Recap

  • Alphabet and Microsoft announced better-than-expected results on Tuesday, driven by strong showings at their core businesses. Read our story
  • A day later, Meta reported its own set of impressive results, defying investor expectations for a fourth-consecutive quarterly drop in revenue. Read our story
  • Amazon’s earnings also managed to top analysts’ forecasts on Thursday, but the firm warned of slowing growth at its cloud computing business. Read our story

✍️ Connecting The Dots

Investors breathed a sigh of relief after Google-parent Alphabet and Microsoft revealed that their main money-makers held up better than expected last quarter. Google's search advertising business exceeded analysts’ estimates, rebounding to make 2% more revenue over the quarter versus the year before, following a 2% decline over the last three months of 2022. Microsoft, meanwhile, reported a 16% increase in cloud computing revenue for the first quarter of 2023, surpassing expectations and dispelling concerns of a significant slowdown – even as corporate clients continue to scale back spending after the pandemic-induced digital services boom.

And while Amazon did manage to wrangle earnings that topped analysts’ forecasts, it warned of, ahem, darker clouds ahead at its AWS cloud division. The tech titan – which has the biggest share in the cloud computing market – saw AWS’s revenue increase by a sluggish 16% in the first quarter, the slowest growth rate since Amazon began reporting the unit’s sales. Investors were then given another jolt when the firm warned that the division’s growth had continued to slow in April, dashing hopes that the company’s most profitable business might have been able to weather the weak environment for tech spending. Some analysts now speculate that AWS’s growth could sink to single digits, which would mark a dramatic fall for a business that entered 2022 with quarterly sales that were up almost 40% from the year before.

In fairness, Amazon is making a big push to cut costs to better han​​​​​​​​dle the slowdown. And those efforts are starting to pay off, with operating expenses increasing by just shy of 9% last quarter – the slowest pace in at least a decade. Facebook-parent Meta’s pushing similar initiatives, aiming to become a leaner, meaner, social media machine by not betting the house on the Metaverse and cutting costs instead. So far, seemingly so good: the firm’s forecast for total expenses in 2023 came in far slimmer than expected. That, coupled with much better-than-expected revenue growth last quarter, helped send Meta’s shares 14% higher after its results announcement.

🥡 Takeaways

1. Investors are going big on Big Tech.

Mega-cap tech stocks have been dubbed “the most crowded trade” in a recent investor survey. All that investor demand has pushed the S&P 500 Information Technology Index up 20% so far this year, compared with a mere 8% gain for the S&P 500 Index. That’s the tech sector’s strongest start to a year relative to the wider market since 2009 – but this outperformance has nothing to do with earnings expectations. See, analysts estimate that US tech earnings plunged 15% in the three months through to March, the third-biggest decline among the S&P 500’s 11 industry groups, with the sector dragged down by higher costs and slowing demand. Instead, the rally is being driven by hopes that the Federal Reserve (the Fed) will soon start cutting interest rates, in turn giving tech stocks’ valuations a leg up.

2. Forget a half-full outlook: investors’ cups are overflowing with optimism.

One valuation model, conducted by Bloomberg Intelligence, shows that investors’ euphoria has gone too far. Tech stocks in the S&P 500 are trading at a forward price-to-earnings ratio (P/E) of more than 25x – but Bloomberg’s calculations show that to justify such a multiple, the Fed would need to cut rates by at least three percentage points. That’s more than five times what the futures market is pricing in for rate cuts this year. And not only is the sector's valuation high in absolute terms, but it’s also inflated compared to the broader market. Tech stocks' forward P/E is approximately 35% higher than the S&P 500 – two standard deviations above the five-year average.

🎯 Also On Our Radar

Options traders aren’t as optimistic as stock investors these days, instead growing more suspicious of the tech sector’s recent outperformance. Case in point: options contracts that hedge against a 10% drop in the Invesco QQQ Trust – the biggest exchange-traded fund tracking the tech-heavy Nasdaq 100 Index – now cost 1.7 times more than options that profit from a 10% rally, a level of pessimism not seen in over a year.



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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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