Next Week’s Earnings Face Elevated Scrutiny After Tech-Stock Wobble

Reports from the market’s coalface suggest investors might be slowly rediscovering the benefits of diversification. They are learning the hard way a lesson that experience had taught their forebears: If you put too much of your investment capital in one place, whether a single stock or a market sector, you are susceptible to greater market volatility. On the upswing, it’s not a problem – the ride is pleasant, the view is wonderful – but the downward plunge is like severe turbulence at an altitude of 37,000 feet: There are stresses, there are strains, and there are risks of personal injury. 

If you’ve been monitoring the business headlines, you know this was a rough week for the tech market, including the Magnificent Seven. The tech royalty got was bludgeoned on the markets, occasioning consternation and some blind panic among their courtiers and retail investors. You could easily imagine the stunned disbelief among those watching the sustained, flickering red indices of the tech portfolios on their phones and computer screens.

The first paragraphs of a Reuters article published yesterday summarized the market jitters:

Investors are ditching some of this year's favourite trades as a retreat in the glitzy megacaps risks snowballing into a multi-pronged selloff that has hit everything from cryptocurrency to gold, and made calling the market's next move ever more complex.

Shares on Wall Street ended lower on Thursday, adding to losses after the S&P 500 (.SPX) and Nasdaq (.IXIC) on Wednesday suffered their worst day since late 2022.

The 2024 "everything rally" - stocks, and especially tech, up; gold and crypto - up; dollar - up; emerging markets, up - may be on hold.

The key word in the preceding sentence is “may.” While this week’s maelstrom was not a false alarm – nobody can deny that tech issues got hammered – it might amount to no more than a brief tempest washing over the tech megacaps. While the results of Alphabet and Telsa were mixed and rankly disappointing, respectively, the narrative might yet take a brighter turn. Quarterly results are on tap next week from Microsoft (Tuesday), Meta Platforms (Wednesday), and then Amazon and Apple (Thursday). After the results and guidance of those heavyweights are received, considered, and digested by market makers, we’ll know whether what occurred this week was a passing storm or the onset of a lengthy hurricane season. 

Do you feel sanguine or apprehensive? If the former, you’re not overly concerned about the occasional bumps on ascending road to riches. Perhaps you’ve been on the tech trail for a while, long enough that your accrued gains are reasonably assured. For you, it’s just a question of when you get out and how much you take with you. 

Capriciousness of the Valuation Insensitive

For others, who perhaps made their moves recently, nervousness is understandable. Traditionally, buying into a high valuation is a risky proposition, but, as we’ve discussed previously, circumstantial evidence suggests that dominant market narratives (let’s call it compelling storytelling) and the ubiquity of trading algorithms have toppled longstanding market conventions. I offer the following excerpt from the Reuters article:

The S&P 500 is trading at almost 22 times expected earnings, an over-two year high, according to LSEG data. The benchmark's recent dip has left it up 14% in 2024.

"On the upside, (markets) are valuation insensitive and this is the same on the downside. The volatility compression you have on the way up goes in the opposite direction on the way down," Mario Baronci, portfolio manager at Fidelity International, said.

Consider that terminology: valuation insensitive. What does that signify? What it suggests is that market is all about momentum, driven by persuasive narratives and supportive algorithms. It’s like a new law of market inertia: that which goes up continues to go up until the onset of a significant narrative shift or an outright narrative reversal inverts the flow. Now a question: Have we reached that point? 

Most professionals on Wall Street maintain a favorable view on the long-term prospects for tech techs, though many concede that bouts of volatility will intermittently result in a few shakes, rattles, and rolls. Keith Lerner, co-chief investment officer at Truist Advisory Services, quoted in the article, forecasts the continuance of a long-term bull market for tech heavyweights, albeit with the caveat that “it’s often two steps forward, one step back.” 

Perhaps, as one portfolio manager suggested, this is just a seasonal retreat, a case of profit taking amid the hazy, lazy summer. According to this thesis, investor capital will return to the slightly battered market in the early autumn after spending a month or more luxuriating in the venerable spa resorts of Swiss francs and Japan's yen. The refreshed money will vigorously embrace the buying opportunities presented by the market's lower prices.

Crisis? What Crisis? 

No reason to panic, then, right? Perhaps, but a Barron’s article published early yesterday intimated that this week’s sharp decline could be the prologue to a deeper slide. The article cited several reasons for a gloomy prognosis, including investors’ disproportionate holdings of leading tech stocks and overly optimistic expectations regarding the timing and scale of returns on prodigious genAI investments staked by the cloud majors. 

Another factor, cited in both the Reuters article and the Barron’s piece, is geopolitical instability, particularly intensifying tech-related trade friction between the U.S. and China, which would affect, to varying degrees, U.S.-based semiconductor companies. (Personally, my view is that China is taking tangible measures not only to reduce but ultimately eliminate its reliance on U.S. semiconductors and related technologies. Consequently, the market should discount any U.S.-based semiconductor company that touts long-term revenue growth and profitability in China. The same goes for many other U.S. or Western technology companies that are heavily exposed to the Chinese market. If it walks like trade war and quacks like one, it’s a trade war, regardless of what the politicians and bureaucrats might say.) 

Also of concern, according to the pundits, is the submissive way the market has been closing trading sessions. As explained in the Barron’s article:

The S&P 500 has been closing at a level below its daily midpoint for the majority of days in the past two weeks. That means that brief rallies have been ending with waves of selling. 

“If the market continues to close poorly, it eventually will have a bigger negative effect on the price action,” writes Frank Cappelleri, a noted market technician and founder of the research firm Cappthesis. 

If the weak trading action causes the index to break below another key level, the drop could end up causing investors a lot of pain. While the S&P 500 has been heading higher for a while, it dipped in late April to hit a low point of 4967. While it has recovered since then, a fall to 5400 would represent a break of the short-term uptrend it has been on since the spring. 

That would point to a drop of another 5% to 7%, based on what the index has done when it has broken short-term uptrends since the start of 2023. Cappelleri says. 

The truth is, the market could go either way. Almost everybody agrees that a lot is riding is next week’s results and guidance from Microsoft, Meta, Amazon, and Apple. The problem, as the railbirds from my misspent youth at racetracks would put it, is the handicap. These tech giants, as they prepare to deliver their results, are under the significant imposition represented by heightened expectations, which are partly of their own creation. What that means is they must not only meet revenue and profit expectations, but beat them resoundingly. Perhaps they have some wiggle room for narrow beats on revenue and earnings bolstered by aggressive, credible guidance for current quarters. On that front, credibility is suddenly at a premium.

A generous dollop of genAI promises might not cut the mustard now. Fermented and fortified AI hype produced an intoxicating buzz, but a throbbing hangover has left the market’s revelers impatient, irritable, and surly. The market wants to see and hear more than boilerplate puffery. The AI narrative is losing its luster, and a script rewrite, if it is to sustain the spirited party, will need to feature more than cameo roles from substance and results.

Regardless of what happens next week, portfolio diversification is always a good idea. There’s hoary axiom about the inherent danger of having all your eggs in one basket; it’s admittedly hackneyed and threadbare, and I have nothing but scorn for cliches (more on which later), but I can’t argue with its enduring wisdom.