Tech is on a comeback tour. The Nasdaq is 13% higher in the past month.
Still, volatility continues to be ever present, and the index is down significantly more than the S&P 500 year-to-date. Some relative strength in the tech sector has come from Apple, Microsoft, and some semiconductor companies as they bounce off their June lows heading into earnings season.
Has the bottom been put into the tech sector? It’s hard to sound the ‘all-clear’ signal on the sector, but let’s look at the set-up as these companies release financial results in the coming weeks.
Pumping the brakes
Let’s start with the bad news.
It’s been hard to avoid the slew of warnings about plans for slowing or reducing hiring by the sector. Companies such as Apple, Alphabet, Microsoft, Meta, Uber, and Twitter are just some of the firms pumping the brakes on hiring. This can be interpreted as a warning signal that profitability is under pressure as the economic environment is slowing. That said, this trend seems much more orderly than the dot-com bust in the early 2000s. While momentum could pick-up, most announcements thus far have not been broad-based, instead the slowdowns impact specific divisions at these companies.
Tech companies are doing their best to not make rash decisions in what has been an orderly economic slowdown. However, making these announcements publicly ahead of earnings helps further lower the bar for a sector that already has low expectations.
Another macro factor impacting all multinational firms is the sharp rise in the U.S. dollar. The tech sector has significant exposure to changes in the dollar as nearly 60% of their revenue is generated overseas. When a company sells products overseas it must convert those sales from foreign currencies to the greenback. The stronger the dollar is against other currencies the greater the negative impact. Earlier this week, Netflix cited a 4% hit to sales due to FX moves in the second quarter – the streaming service company warned of a whopping 7% negative impact from a rising USD expected in Q3. IBM also predicted an increased negative impact from currency on sales in the current quarter.
This will be a consistent theme that receives significant attention throughout earnings season as it’s another headwind that the tech sector will have to contend with. Apple, Intel, Amazon, Micron and Qualcomm are some of the most highly exposed tech companies in the S&P 500 index.
Kitchen sinking quarter
We’ll know a lot more about not only the state of the technology sector after next week but also the broader economy. Expect volatility as big tech kicks off earnings season next week with Alphabet, Microsoft, Apple, Amazon and Intel all on the docket.
So far, the reaction to earnings season has been mixed for the S&P 500. While we haven’t seen drastic EPS misses or many major guidance cuts, price reactions have varied by sector. The tech sector is in a similar position. While only seven tech companies have reported thus far, second quarter results are coming in better-than-expected. Where things get murky is in the outlook. Several tech companies have cut guidance. Some even threw the whole kitchen sink at their projections – like Micron and Seagate Technologies. Interestingly, tech stocks have been reacting well to lowered guidance. Of those that have reported, their stocks are almost 8% higher since reporting results. That’s not completely surprising given how beaten up the sector got over the past several months and how pessimistic sentiment is for the sector. Investors may view the downbeat outlooks as a signal that the worst case is being accounted for.
It’s not all doom and gloom. Paychex raised guidance, Oracle maintained guidance and the world’s largest chipmaker, Taiwan Semiconductor, boosted its Q3 outlook. The sector is likely to see divergences by industry and end-markets. Consumer-driven companies are likely to be more aggressive with guidance reductions than those serving businesses as demand for many consumer electronic products was pulled forward during the pandemic years. One thing is for sure, volatility will be present as earnings season unfolds.
Improving valuations and technicals
Bigger picture, the technology sector’s valuation has retreated this year. Consider that the group traded with an elevated forward price-to-earnings (P/E) ratio just below 30x to start 2022 but has now retreated to a much more reasonable earnings multiple of 20.5x. To put that figure in context, the defensive consumer staples sector is just as expensive as the growth-oriented tech space. Usually tech is more expensive.
Sometimes investors can find truth in price action. The Nasdaq 100 ETF closed above its 50-day moving average for the first time in 68 trading days on Tuesday. Bespoke Investments notes that streak was the longest since 2008, though the longer-term trend is still downward-sloping, which suggests the near-term up trend hasn’t been solidified yet. Nevertheless, the tech-heavy ETF trades at its best level since early June. Time will tell if the sector is out of the woods, but technical signals are improving.
The bottom line
There’s good and bad news in the technology sector. A lot of questions will have been answered after next week’s key earnings reports, but there are some encouraging signs. After a big selloff to start the year, tech stocks’ valuation looks much better, and the technical picture has taken a positive turn. Buckle up for what is sure to be an interesting earnings season.
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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.