Big Tech’s Profit Engine Sustains S&P 500 Earnings

Investors seeking a glimmer of positivity are once again turning their attention to a familiar group: the Big Tech companies. Anticipating a 34% average profit growth from five tech giants, earnings season in the tech sector is kicking off this week amidst a growing list of concerns in the stock market.

Having trimmed their workforce significantly to reduce expenses, the largest US technology and internet firms are now churning out profits that rival those seen two years ago, during the pandemic-induced surge in digital services and electronic device sales. The prevailing expectation is that they will help compensate for the lackluster earnings performance in industries like energy and healthcare. The five largest companies in the S&P 500 Index—Apple Inc. (AAPL), Microsoft Corp. (MSFT), Alphabet Inc. (GOOG), Amazon.com Inc. (AMZN), and Nvidia Corp. (NVDA)—comprise roughly 25% of the benchmark’s total market capitalization. Analyst estimates gathered by Bloomberg Intelligence project a 34% year-over-year increase in their earnings.

In contrast, the S&P 500 as a whole doesn’t appear as robust. Profit expectations for the index are relatively flat, but this picture would be significantly bleaker, with a potential 5% drop, without the contributions of these five tech giants.

Leading the Charge

Soaring interest rates have recently rattled the markets, with the 10-year Treasury yield reaching its highest point in over a decade. An unexpectedly high inflation report has investors preparing for the possibility of the Federal Reserve maintaining tight monetary policy or even raising interest rates further. Against this backdrop, concerns about a potential recession have resurfaced, fueled by ongoing conflicts in the Middle East. Tech stocks have faced headwinds due to these factors, with the tech-heavy Nasdaq 100 experiencing two consecutive months of decline. However, they continue to outperform the broader market significantly. The substantial portion of the S&P 500’s 13% YTD gain is attributable to the five major tech companies.

Netflix Inc. (NFLX) and Tesla Inc. (TSLA) are set to kick off the tech sector’s earnings season this Wednesday, followed by Alphabet, Microsoft, Amazon, and Meta Platforms Inc. (META) reporting the subsequent week. Apple is scheduled to announce its earnings on November 2nd, followed by Nvidia on November 21st.

Potential Obstacles Ahead

One potential obstacle to a rally fueled by earnings is that much of the expected positive news may already be factored into stock prices. Alphabet and Amazon have surged by more than 50% this year, while Apple and Microsoft have gained nearly 40%.

In addition to rising profit forecasts, these stocks have benefited from speculation that the tech giants are in the best position to capitalize on generative artificial intelligence, despite Nvidia being the only one among them to demonstrate significant financial gains from this trend. Investors are concerned that, even after recent declines, the stock-market valuations of Big Tech companies remain elevated. Apple and Microsoft, for instance, are trading at approximately 27 and 29 times estimated earnings, respectively, well above their historical averages over the past decade, whereas the S&P 500 as a whole is trading at around 18 times estimated earnings.