Bloomberg—The incessant growth of big technology has been a cause of faith for investors since the beginning of the last stock market rally, in October 2022.
But with some Dim earnings outlook for the rest of 2024it is likely that Other corners of the market may be needed to keep share prices rising.
“For the market to have a similar return in the second half, a broader participation would be needed” says Keith Lerner, co-chief investment officer and chief market strategist at Truist Advisory Services.
It looks like that can happen.. Although Big Tech’s profit growth is expected to slow dramatically from now on, Sectors such as materials and healthcare are expected to post profit growth of approximately 25% in the fourth quarterafter registering contractions of 20% or more in the first quarter.
A slowdown in the growth of profits of large technology companies is expected | Percentage change in profits(Bloomberg Intelligence)
“I think those sectors are starting to look quite interesting, and I mean energy, materials, discretionary consumption, industrial, financial”said Ohsung Kwon, quantitative and equity strategist at Bank of America. “I think all of those cyclical sectors are going to do better in the second half of the year.”
That rotation already appears to be underway. In BofA, clients withdrew nearly $2.2 billion from tech stocks during the week ended May 31, the second-most in the bank’s data dating back to 2008.. The largest customer inflows went to the consumer discretionary sector, which is up 1.9% this year, making it the second-worst performer in the S&P 500.
“The discretionary sector is traditionally a big driver of S&P 500 earnings and a place that often picks up losses,” said Michael Casper, equity strategist at Bloomberg Intelligence.
We cannot give up technology
This does not mean that investors are going to give up on big technology. ANDhe S&P 500 is up 12% this year, and its five greatest values -Microsoft Corp, Apple Inc, Nvidia Corp, Alphabet Inc and Amazon.com Inc – are responsible for more than half of that profitwith markets captivated by the rise of artificial intelligence.
In the processthose five companies have added a combined market value of $2.9 trillion in 2024. This has contributed to information technology being by far the largest sector in the S&P 500, with a weighting of 31%. The next closest groups are financial and healthcare, with around 12%.
What’s more, it’s not that technology companies have stopped growing. What is happening is that the rate of expansion of its profits is slowing down. After three consecutive quarters of earnings growth above 44%, the five largest companies in the S&P are expected to see that figure fall to 29% in the second quarter, before settling into the teens in the second half of the year, according to data collected by Bloomberg Intelligence.
“We still think that Big Tech is likely to outperform, but at a more moderate level,” Lerner says. “Investors will continue to bet on these companies, which are high quality, have strong cash flow, a lot of cash on the balance sheet”.
In many ways, companies are suffering from their past success, as their strong 2023 results make comparisons with 2024 difficult. But companies continue to grow profits and generate healthy margins after aggressive cost-cutting efforts.
High expectations
“Big technology companies have the responsibility to live up to expectations” says Adam Sarhan, founder of 50 Park Investments. “Otherwise, the stock market will be forced to recalibrate and sell, especially if earnings growth in other sectors does not improve from now on.”
Part of the challenge for technology investors is that stocks are already quite expensive. Nvidia is trading at 40 times expected earnings for the next 12 months, compared to 21 times for the S&P 500. Microsoft does it at 33 times, and Apple at 20 times. Microsoft trades at 33 times, and Apple at 29 times. Even Alphabet, relatively cheaper (21 times), is trading above its average of the last 10 years.
Valuations of big technology companies | Expected price/earnings ratio versus S&P 500Source: Bloomberg(Bloomberg)
“As non-tech sectors begin to increase their profits, The premium that investors paid for technology should reduce in relative terms compared to other sectorssays BofA’s Kwon.
An asymmetry is also emerging in the directions of Big Tech values, as the companies’ earnings outlooks diverge.
With investors focused on AI, Nvidia has soared ahead of the pack, rising 144% this year and remaining the best-performing stock in the S&P 500. Meta Platforms, parent of Facebook, has added 39%, while Alphabet, parent of Google, has risen 25% and Amazon has gained 21%. Microsoft, for its part, has not kept pace, with a relatively small increase of 13%. And then there’s Apple, which has spent most of the year in the red and is up just 2.3% in 2024.
“The core business lines of each of these companies are no longer moving in the same direction as during the pandemic recovery, so that is also causing profits to cool,” says BI’s Casper. “The seven magnificent stocks no longer move as an omnipresent block, and that hurts their earnings potential as a cohort because trading has now broken down.”
Choose sectors
However, relying on momentum from the rest of the market carries its own risks. For example, healthcare margins are faltering despite enthusiasm for anti-obesity drugs, as the group continues to grapple with accusations from Big Pharma. Meanwhile, consumer discretionary sector profit growth is being driven by just a handful of companies, such as Amazon and home improvement retailer Home Depot Inc.
That means more sectors than these will have to post profit growth, particularly consumer discretionary and those closely tied to the health of the economy: industrials and financials, Casper said. However, each of these groups carries its own risks.
“Consensus earnings forecasts are pretty poor for most retailers not named Amazon,” he said. “Financiers and industrialists could pick up the pace, although regional banks still face the hangover from (the bankruptcy of Silicon Valley Bank)”.
In the end, the success of the stock market in 2024 may still come down to Big Tech, directly or indirectly. With AI expected to have a transformative impact on so many industries, technological development is likely to spread to other parts of the economy, lifting those stocks along the way.
“As long as big tech companies continue to meet their profit forecasts, it bodes well for the economy,” says 50 Park’s Sarhan. “Which will help drive the stock rally even further because there are other industries outside of technology that will benefit from AI.”
Read more at Bloomberg.com
