We’re At The Cusp Of An Earnings Recession, And Tech May Lead The Way

We’re At The Cusp Of An Earnings Recession, And Tech May Lead The Way
Reda Farran, CFA

11 months ago2 mins

After seeing their valuations plummet last year, US tech stocks are about to face their next hurdle: falling profits. This chart shows the annual growth in quarterly earnings of the S&P 500’s tech names. Note that the rate shown for the fourth quarter of 2022 is based on analyst projections and reveals a big, 9.2% drop from the year before, for what would be the steepest decline since 2016. Also notable here is how quickly sentiment has soured: just three months ago, analysts saw profits coming in flat, averting the second-straight quarterly decline that’d classify this as an “earnings recession”.

This week, investors got a preview of those falling earnings: Microsoft, which kicked off the sector’s reporting, saw its profits fall 12% last quarter from a year ago. A $1.2 billion cost piled onto net income from the firm’s decision to eliminate 10,000 employees played a role, sure, but even if you erase that factor, you’d still have an earnings slide of 7%. The firm’s CEO had previously acknowledged that the industry is going through a period of deceleration after the tech spending spree of the pandemic.

This all matters because the tech sector has huge sway over the direction of the overall market, with the group accounting for more than a quarter of the S&P 500’s market capitalization and about half of the Nasdaq 100’s. The big concern now is that stock valuations are still far from cheap, despite the cuts to earnings estimates and last year’s 33% fall in the Nasdaq 100. The index is currently priced at about 22 times projected profits over the next 12 months, compared with an average of 20.5 for the past decade – and any further cuts to estimates would only make it look more expensive. For reference, the multiple bottomed at 17.7 during the 2020 Covid crisis and at 11.3 in 2011, in the wake of the global financial crisis.



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