Big Tech’s Profit Machine Is Propping Up S&P 500 Earnings

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(Bloomberg) — With the list of stock-market worries growing seemingly by the day, investors looking to earnings season for a dose of good news are hanging their hopes on a familiar group: Big Tech.

After slashing thousands of jobs to cut costs, the biggest US technology and internet companies are pumping out profits similar to those generated two years ago when the pandemic sent sales of digital services and electronic devices soaring. The expectation now is that they’ll help pick up the slack from industries like energy and health care that are still mired in an earnings slump.

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The five biggest companies in the S&P 500 Index — Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc. and Nvidia Corp. — account for about a quarter of the benchmark’s market capitalization. Their earnings are projected to jump 34% from a year earlier on average, according to analyst estimates compiled by Bloomberg Intelligence. 

The S&P 500 as a whole isn’t looking nearly as strong. The index’s profits are expected to be roughly flat, but they’d face a drop of around 5% without those five behemoths.

“It’s very important for the big tech stocks to deliver” and bolster confidence broadly, said Gary Bradshaw, a portfolio manager at Hodges Capital Management. “The Street expects earnings to be good across the board. Megacap tech stocks have whatever it takes to lead the market in the final quarter of the year.”

Leading the Market

Soaring interest rates have rattled markets this month with the 10-year Treasury yield hitting the highest in more than a decade. A hotter-than-expected inflation report has investors bracing for the Federal Reserve to keep policy tight, and potentially hike again. That backdrop has reignited fears about a potential recession that have only been heightened by conflict in the Mideast. 

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Tech stocks have faltered in the face of those headwinds, with the tech-heavy Nasdaq 100 tumbling for two straight months. But they’ve still hugely outperformed the overall market. The five key big-tech companies account for the bulk of the S&P 500’s 13% advance this year. 

Netflix Inc. and Tesla Inc. are scheduled to kick off tech-related earnings Wednesday. Alphabet, Microsoft, Amazon and Meta Platforms Inc. report the following week. Apple announces Nov. 2 and Nvidia on Nov. 21.

After robust second-quarter earnings, “we need to see more of the same in the third-quarter results,” said Mike Bailey, director of research at FBB Capital Partners. Given their big weighting, “you can bet that the rest of the market will play follow the leader as big tech earnings unfold this quarter.”

He said he sees “fairly low odds of a tech earnings wreck this quarter.”

Investors have good reason to be optimistic. In the past century, the S&P 500 has rallied during reporting season about two-thirds of the time, data compiled by Bloomberg show.

Roadblocks Ahead

One potential roadblock to an earnings-fueled rally is that a lot of the anticipated good news may be priced in. Alphabet and Amazon have gained more than 50% this year, while Apple and Microsoft have advanced nearly 40%.

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On top of rising profit expectations, the stocks have benefited from bets that the tech giants are best positioned to capitalize on generative artificial intelligence. That’s despite Nvidia, whose shares have tripled this year, being the only one to show a substantial financial boost from the trend.

A source of concern for investors is that even with recent declines, big tech’s stock-market valuations are still elevated. Apple and Microsoft are priced at about 27 and 29 times estimated earnings, respectively, well above averages over the past decade. That figure is around 18 for the S&P 500 as a whole.

Expensive share prices put pressure on companies to deliver strong earnings, according to Kim Forrest, founder and chief investment officer at Bokeh Capital Partners. 

“They have to constantly deliver or they will lose the attention of investors,” she said in an interview. “Somebody needs to keep buying, and these rich valuations need to be justified.”

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