(Bloomberg) -- Wall Street analysts are starting to cut earnings estimates for some of the world’s biggest technology companies, undermining the argument that their stocks look cheap after this year’s market rout.
Amazon.com Inc (NASDAQ:AMZN)., Nvidia (NASDAQ:NVDA) Corp. and Alphabet (NASDAQ:GOOGL) Inc. are among those that have seen earnings estimates fall over the past month amid growing speculation that the Federal Reserve’s aggressive path of interest-rate hikes will trigger a recession. JPMorgan Chase & Co. (NYSE:JPM) on Wednesday lowered estimates on 26 internet companies, including Twitter Inc (NYSE:TWTR). and Spotify Technology SA (NYSE:SPOT).
For months, estimates for many megacaps held firm even as soaring costs and surging interest rates torched trillions of dollars from market values. With angst over the risk of a recession building, analysts are starting to step back from their rosy assessments before the second-quarter earnings season starting next month. That has them edging closer to the many investors who have been anticipating weaker profits.
“Corporate America has done an amazing job at passing on pricing pressure but I’m not sure that continues,” said Bob Doll, chief investment officer at Crossmark Global Investments. “The earnings picture is going to get a little darker.”
Tech stocks dipped on Wednesday, with the Nasdaq 100 Index down 0.3%.
Estimates for the vast majority of companies in the S&P 500 Index have remained steady. In fact, profits from companies in the benchmark are projected to expand more than 10% this year, up from a forecast of 8.7% at the start of the year, according to Bloomberg Intelligence.
The aggregate forecast for 2022 earnings per share for the tech-heavy Nasdaq 100 Index, though, peaked in February and has since fallen almost 3%, according to Bloomberg data.
For battered tech stocks, falling estimates raise the prospect of more selling pressure as the denominator in the price-to-earnings ratio sinks, making the equities look more expensive. That throws up a hurdle to a sustained rally in the S&P 500, considering the sector has the biggest weighting in the index.
Shrinking Valuations
After dropping 29% in 2022, the Nasdaq 100 is priced at about 19 times projected profits, close to the lowest since the start of the pandemic, and down from a peak of 31 after the Fed unleashed a flood of stimulus in 2020.
If profits do in fact start to shrink, that would erode the argument that many stocks are in bargain territory, says Michael Arone, chief investment strategist at State Street (NYSE:STT) Global Advisors’ U.S. SPDR business. He estimates that earnings projections could fall as much as 40% to accurately reflect slowing growth and the persistent inflation that’s threatening margins.
“Stocks look deceptively cheaper because estimates haven’t fallen,” Arone said. “Current estimates suggest growth north of 10%, but they need to be reduced to reflect a cyclical slowdown, if not something worse.”
Read more: Morgan Stanley’s Shalett Says Analysts Are ‘Deer in Headlights’
Of course, not all megacap estimates are dropping. Projections for Apple Inc (NASDAQ:AAPL). and Microsoft Corp (NASDAQ:MSFT)., the two most valuable American companies, have barely budged, although their stocks have tumbled more than 20% this year.
Earnings Season
There have been signs that this earnings season may bring more gloom for technology investors. In May, Snapchat owner Snap Inc (NYSE:SNAP). blamed a sudden slowdown in its advertising business on a weakening economic outlook, sending jitters through the ranks of companies that rely on digital ads as their main source of revenue. A week later, Microsoft cut forecasts as a result of the surging dollar, which reduces the value of American companies’ overseas earnings.
The five companies with the greatest weighting in the S&P 500 -- Apple, Microsoft, Alphabet, Amazon and Tesla (NASDAQ:TSLA) Inc. -- are projected to see second-quarter profits drop by more than 20% from the same period a year ago, when their earnings jumped 88%, according to Bloomberg Intelligence.
For Citigroup Inc (NYSE:C).’s Scott Chronert, all of the bearish expectations could set stocks up for a strong second half of the year if earnings aren’t as bad as feared. He expects profits to hold up and projects the S&P 500 to rally about 10% by year-end, the strategist wrote in a research note Monday.
Earnings releases in the weeks ahead are going to be crucial for investors in deciding whether that bullishness is warranted.
“Given what we know of slower economic conditions, the dollar’s strength and the impact that has on multinational profits, and margins coming under pressure, I think consensus estimates seem rather ambitious,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott.
Tech Chart of the Day
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(Updates to market open.)
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