Earnings May Not Support Further Mega-Cap Tech Stock Rally

This month’s rally in the mega-cap technology stocks of Apple (APPL), Alphabet (GOOGL), and Microsoft (MSFT) has been fueled by their safe haven status. Concern about contagion from the banking turmoil has pushed investors toward the cash-rich balance sheets and steady revenue streams of mega-cap technology stocks.  Three other mega-cap technology stocks, including Nvidia (NVDA), Meta Platforms (META), and Tesla (TSLA), have also benefited from the banking sector woes. 

Although mega-cap technology stocks have rallied this month on their safe haven demand, further upside in their share prices may be limited.  Valuations of the mega-cap tech stocks are elevated.  Also, the earnings outlooks for the companies have been clouded by economic concerns.  Finally, falling bond yields, a key contributor to the recent rally in technology stocks, could prove short-lived if the Federal Reserve keeps raising interest rates.

The Nasdaq 100 Stock Index ($IUXX) (QQQ) has rallied +6% this month and is up more than +22% from its 3-1/2 year low in October as the banking sector turmoil sent bond yields tumbling and sparked a rally in mega-cap technology stocks.  However, Truist Advisory Services said, “right now, you’re paying a big premium to be in the sector at a time of above-average risk, which suggests your return potential from here doesn’t look great.”

The rally in mega-cap technology stocks has not been matched by an improvement in fundamentals. According to Bloomberg Intelligence data, earnings for technology information stocks are expected to fall -7.7% in 2023, compared with the growth of +5.2% expected six months ago.  Also, forecasts for revenue growth for the sector have turned negative over the same period, with consensus moving from a +6% increase to a -0.5% decline.

The falling earnings estimates, along with the recent rally in technology stocks, have inflated valuations and made the stocks look pricier at a time when the sector is already above its long-term multiples.  The Nasdaq 100 trades at 24 times estimated earnings, higher than its 10-year average of 20.  Apple and Microsoft, the two largest companies in the Nasdaq, are notably above their long-term averages, while Nvidia is almost double its 10-year average.

UBS Asset Management remains optimistic about tech over the long term but said that “there’s been a continual stream of negative events that have people taking safety in big tech. Now valuations are generally stretched, and if investors warm to the idea that the world isn’t ending, they may feel this trend is played out.”

On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.