Tech stock rally – The moment of truth

Companies in the Nasdaq 100 are headed into earnings season with momentum that approaches the unprecedented, their value up by more than $1 trillion since October.

Now the world finds out if the rally made any sense.

Twenty-six constituents are due to report quarterly results next week, including three of the four biggest U.S. companies, over one blistering 48-hour stretch starting Tuesday.

With trillion-dollar-plus market capitalizations and a doubling in Apple Inc. since 2018 to account for, it’s possible investors will be in a less-forgiving mood than usual.

As things stand now, Nasdaq stocks are perched at the highest forward valuation since 2007 and investors are getting progressively less patient with failure.

Already this reporting season, companies in the broader market whose sales and earnings trailed analyst estimates have seen their shares pummeled the next day by the most in five quarters.

“The market isn’t going parabolic, but some of these tech stocks really have,” said Randy Frederick, a vice president of trading and derivatives at Charles Schwab. “If you miss the bar, you’re going to get punished, no question about that.”

A four-day week before the landing of big tech earnings saw the Nasdaq 100 slip 0.4% as stocks wavered amid concern over the spread of a virus that started in China. Seven straight weeks of gains have pushed the index to 23 times its forecast earnings, about 30% higher than its 10-year average.

That valuations are stretched doesn’t mean stocks can’t rally further. It does raise the drama headed into earnings season.

The latest leg of the bull market has come at a time when overall earnings have stopped rising for most industries — the reason valuations have swelled so much. While the index rose every quarter of 2019 in terms of price, profits fell in two and are now forecast to contract in a third.

Given the Nasdaq surged 38%, investors have obviously been OK looking past those numbers. But any indication that 2020’s expectations are optimistic may be taken poorly by stock bulls.

That dynamic is writ large in the tech industry, where earnings have dropped 3% or more in each of the past three quarters. Computer and software makers are expected to post a 0.8% profit contraction in the three months through December. Early returns have been encouraging.

Texas Instruments, a bellwether for chip stocks, posted results that topped estimates. Intel Corp. reported sales guidance that came in above industry trends.

Despite the recent quarterly hiccups, combined net income of five largest tech companies — Apple, Amazon, Microsoft, Alphabet and Facebook — totaled $40 billion in the third quarter, 38% above the same period two years ago.

“Multiples have expanded, but quarter-over-quarter these companies continue to grow earnings and that’s the whole key,” said Gary Bradshaw, a Texas-based portfolio manager at Hodges Capital Management, who owns shares of Apple, Microsoft, Amazon and Facebook.

“It’s one of the areas in the marketplace where you’re seeing good growth. This isn’t 1999 or 2000 when you were valuating those tech stocks on eyeballs.”

The cost of falling short has risen as well. A broader gauge of tech, online retail and Internet services stocks dropped 0.9% the day after reporting a miss on second-quarter sales and earnings per share, data compiled by Credit Suisse show. In the third quarter, the average slump was 6.8%.

Apple will release quarterly figures on Tuesday, and analysts are focused on how the firm fared during the holiday season and dealt with uncertainty around tariffs. Microsoft, up 62% since the start of 2019, reports Wednesday.

Investors will see whether the demand for its cloud-computing programs remains strong. Facebook, which has rallied 66% over that stretch, reports the same day.

“I’d expect a little more leadership out of value-oriented sectors, more economically sensitive parts of the market,” Jeff Kleintop, chief global investment strategist at Schwab Center for Financial Research, said by phone.

“I think investors seem to be comfortable with sticking with the leaders that got them here, at least for the time being.”

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Tech stock rally – The moment of truth