By Lewis Krauskopf
NEW YORK (Reuters) – Earnings reports from the four largest US companies by market cap next week could test an emerging rally as stocks have recovered from another low.
Apple, Microsoft, Google’s parent company Alphabet, and Amazon together make up 20% of the weight of the S&P 500 and more than a third of the Nasdaq Composite.
Investors are viewing the growth giants as guard rails for how American companies are faring in a year when inflation has skyrocketed, and are urging the Federal Reserve to quickly enact a series of gargantuan rate hikes that have hurt markets and fears of an imminent recession.
“When these megacaps aren’t doing well, the question becomes, who can do well?” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management. (Graphic: market values of megacaps vs. stock market, https://fingfx.thomsonreuters.com/gfx/mkt/zdvxdydxzvx/Pasted%20image%201666369186528.png)
The S&P 500 is up nearly 5% from its year-end low of Oct. 12 after posting its biggest weekly gain since late June. Even with the recent rebound in stocks, the index is down 21% so far in 2022, on course for its biggest drop since 2008.
Robust corporate earnings have been a bright spot this year, although doubts are growing about how sustainable they will be. With the majority of S&P 500 companies yet to report, third-quarter earnings are estimated to have risen 3.1% from the year-ago period, which would be the weakest performance in two years, according to Refinitiv IBES, while earnings growth is expected in 2023 fell to 7.2% from 7.8% on October 1st.
Next week’s reports from the four megacaps could reveal whether companies with dominant positions are able to show solid performances despite concerns about a possible economic slowdown.
Because of their heavy weighting, “if these stocks don’t make it, that puts pressure on indexes to fall further,” said Chuck Carlson, chief executive officer at Horizon Investment Services.
Microsoft and Alphabet will report Tuesday, with Amazon and Apple reporting Thursday.
Apple stock is the only one of the megacaps to have outperformed the broader market this year. Shares of the iPhone maker, which accounts for a 7% weighting in the S&P 500, are down about 17% in 2022; Microsoft and Amazon are each down about 28%, while Alphabet is down 30%. (Graphic: Megacaps vs. US stock market, https://graphics.reuters.com/USA-STOCKS/MEGACAPS/gkvlwmwlepb/chart.png)
Despite these hefty losses, investors have maintained their exposure to the megacap stocks. According to Morningstar Direct, actively managed U.S. mutual funds and exchange-traded funds held 11.41% of their portfolios in these four stocks combined, up from 11.44% at the end of 2021, according to the most recent available data.
Investors are generally attracted to large companies because of their financial strength and competitive advantages, which theoretically lead to increased profits even in uncertain economic times.
Still, only Apple has beaten analyst estimates for earnings and revenue in the last two quarterly reports, according to Refinitiv data.
“The bar is set higher for Apple because it’s outperformed and earnings haven’t contracted yet,” said Walter Todd, chief investment officer at Greenwood Capital.
Questions arise about the other companies’ key market areas, including PCs for Microsoft, ad spend for Alphabet, and consumer strength for Amazon.
All three are banking on cloud computing businesses, which will be the focus next week, according to Charlie Ryan, partner and portfolio manager at Evercore Wealth Management.
“Cloud would be the pillar to put your hopes on when they report,” Ryan said. “It’s been a sustained strength for quite some time and any deviation from that would be a problem.”
Meanwhile, rising US bond yields are putting pressure on valuations and complicating the picture for technology and other growth stocks, for which higher yields are heavily discounting expected future earnings. Yields continued to rise this week, with the yield on the benchmark 10-year Treasury note hitting a new 14-year high.
All four stocks are valued higher than the S&P 500, which is trading at nearly 16 times forward earnings estimates. P/E ratios for Apple and Microsoft are both around 22 times, Alphabet is trading at 17.5 times, while Amazon is trading at 60 times, according to Refinitiv Datastream.
“These stocks have typically sold at earnings multiples that are on the higher side,” said Carlson of Horizon Investment Services.
(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and David Gregorio)
