Profit growth expected to slow down, the halo of US tech giants fading

According to the information obtained by Zhitong Finance and Economics APP, as major US tech giants prepare to announce their earnings this week, the slowdown in profit growth is eroding some of the invincibility that surrounds them. Whether this trend can be reversed will largely determine whether the stock market's upward trend can continue.

Data compiled by Bloomberg Intelligence shows that the five companies with the highest market capitalization in the S&P 500 Index - Apple (AAPL.US), Nvidia (NVDA.US), Microsoft (MSFT.US), Alphabet (GOOGL.US), and Amazon (AMZN.US) - are expected to see an average profit growth of 19% in the third quarter. Although this will easily surpass the expected profit growth of 4.3% for the S&P 500 Index, it will also be the slowest overall profit growth for these five companies in six quarters.

Furthermore, it is expected that by 2025, the gap in profit growth between large tech companies and other companies will continue to narrow. By that time, the approximately 35% quarterly profit growth achieved by these large tech companies last year will become history. Therefore, the question for investors is what this means for these large tech companies and whether they can continue to lead the rise of the US stock market indices.

"Slowdown in profit growth for the 'Big Seven' of the US stock market"

Andrew Choi, portfolio manager at Parnassus Investments in San Francisco, said, "Market sentiment is much more volatile than in the past few quarters, and the factors driving the market now feel more negative." "This does not mean that the upward trend has ended, but there are opportunities elsewhere, especially when there is ongoing debate about the valuation and profit momentum of large tech companies. Now, every story has some controversial or debatable factors, all of which will affect market sentiment."

1. Market Rotation

For most of the past two years, tech giants have led the rise of the S&P 500 Index, due to their expanding profits and investors' willingness to continue paying higher returns for these profits.

However, the situation has changed in recent months. Since reaching a peak on July 10, the Bloomberg Magnificent 7 Index - composed of the aforementioned five tech giants along with Meta (META.US) and Tesla (TSLA.US) - has fallen by 2%. This performance lags behind all major sectors of the S&P 500 Index during the same period, with utilities, real estate, finance, and industrial stocks rising by over 10%, while the overall index has risen by 3.1% All of this has put large tech companies in an unfamiliar position: at a disadvantage in the stock market. As valuations rise, they are facing stricter scrutiny, with investors questioning when their massive spending on artificial intelligence projects will pay off.

Baird investment strategist Ross Mayfield said, "The situation where tech stocks lose market leadership may continue until the end of this year, but that won't scare us away from holding them for the long term." "There are obviously risks of slowing profit growth, valuations may be somewhat high, but they still bring so much growth, and there is still great potential for profit growth in the coming years."

Tesla has already announced better-than-expected third-quarter results and provided encouraging guidance. Other large tech companies will release their earnings reports this week. Alphabet will report earnings on Tuesday, Meta and Microsoft on Wednesday, Apple and Amazon on Thursday, and Nvidia is expected to report earnings by the end of November.

2. The Future of Artificial Intelligence

The tech giants reporting earnings this week each have their own issues. Microsoft is facing concerns about its prospects in the field of artificial intelligence. Apple has seen preliminary signs of lukewarm demand for its latest iPhones, despite long-term optimism driving the company's stock to a new high last week. Amazon investors are worried that the company's heavy capital spending will erode profits. With the U.S. Department of Justice investigating Alphabet's monopolistic behavior, there is regulatory uncertainty for the company.

Artificial intelligence will be a major focus for investors, especially as these companies have invested heavily in expensive AI infrastructure. In the third quarter of this year, capital expenditures for Microsoft, Alphabet, Amazon, and Meta are expected to reach $56 billion, a 52% increase from the same period last year.

Investors generally believe that these companies' investments in artificial intelligence represent the future of technology. But there is no evidence to suggest that companies like Microsoft, which have already integrated AI capabilities into their software products, will immediately see a surge in profits. Disappointment over the gap between AI spending and performance disrupted the second-quarter earnings season. Now, it is raising concerns about future profit margins.

Bloomberg Intelligence strategists Gina Martin Adams and Michael Casper said, "Profit growth is being offset by the surge in capital spending related to artificial intelligence. This means that profit margins have likely peaked, at least in the short term."

3. Valuation Challenges

Despite the weakness in the stock prices of large-cap stocks, many of these companies are trading at valuations above historical averages. Data shows that Apple's forward 12-month price-to-earnings ratio is 32 times, compared to an average P/E ratio of 20 times over the past decade; Microsoft's forward P/E ratio is 33 times, compared to an average P/E ratio of 25 times over the past decade.

Bellwether Wealth Chief Investment Officer Clark Bellin said, "If you focus on tech stocks, you would ask, is their profit growth really enough to catch up with these P/E levels? Or do recent strong performances reflect investors' concerns about missing out on opportunities?" "You cannot ignore the impact of momentum, but at times, 'the music may stop.' People need to control their expectations during earnings season."

It is certain that professionals on Wall Street overwhelmingly remain bullish on large tech companies. Data shows that about 90% of analysts covering Microsoft, Alphabet, and NVIDIA have given a "buy" rating to these companies' stocks, while this ratio for S&P 500 constituents is around 53%.

Andrew Choi stated, "The reasons for optimism are quite simple. Despite various concerns, they can still provide above-average profit growth, exposure to artificial intelligence, strong capital returns, and lower risks compared to other stock market sectors." "It's hard to find companies with such rapid profit growth, and they have many attractive qualities."