Google's post-earnings plunge is reminiscent of Tesla's misfortune. It turns out that overvaluation is to blame!

According to the Zhongtong Finance APP, in a world where bond yields are volatile, returns are uncertain, and the information from the Federal Reserve is mixed, are you looking for a unified theory to explain the stock market? Try valuation.

In short, after the continuous seven-month rise of a few AI super stocks, their valuations are too high. What else can explain why the profit losses of Tesla (TSLA.US) and Alphabet (GOOGL.US) turned into single-day declines of over 9% within a week? For Google's parent company, this is the second most severe sell-off in history after announcing its earnings report.

Fixed income pressure and macroeconomic uncertainty are intertwined - weak demand for US Treasury bonds has pushed up yields, while growing supply has worried bond traders - but on a day like Wednesday, price surges were the catalyst.

Michael O'Rourke, Chief Market Strategist at JonesTrading, said, "The pricing of these companies is perfect." "Once any signs of weakness appear, they will be heavily sold off."

Figure 1

This is a story that is often mentioned - the rapid disappearance of stock market surges. As profits and expectations remain stable while stock prices rise, the entire rebound is the result of people paying more money for the same profits. Now, with a 5% yield on government bonds enticing the same funds to flow back, the forward P/E ratio of the Nasdaq 100 index has dropped from around 27 to around 22 in three months.

On Wednesday, the disappointing cloud computing performance of Google's parent company, Alphabet, had a greater impact on the market than Microsoft's strong sales performance, causing the Nasdaq 100 index to fall by 2.5%, marking the largest single-day decline this year. The tech-heavy index has fallen more than 1% for the fourth time in the past nine trading days and is currently down more than 9% from its peak in July.

Although Google's third-quarter revenue exceeded expectations, partly due to strong ad sales, reflecting growth in search and YouTube, investors still reduced its market value to nearly $180 billion and sold off stocks with a P/E ratio of over 21 times and expected sales of over 6 times before the stock price plummeted.

Mike Bailey, Research Director at FBB Capital Partners, said, "Bears are looking for any stocks that have performed well this year but have slight profit issues as selling targets. Google fits this criteria."

It is certain that in many ways, selling based on valuation rather than business challenges (such as declining sales or credit tightening) minimizes trauma for investors. Google's stock price fell by $13.20 on Wednesday, equivalent to about a quarter of the increase from the 2023 high point. As of mid-October, the stock has risen nearly 60% this year, with only recent buyers experiencing losses.

Figure 2

It is worth mentioning that Google's sell-off followed Tesla's sell-off last Thursday. As of last Wednesday, the electric vehicle manufacturer has accumulated a 97% increase this year, ranking third among the constituents of the S&P 500 index. However, the company's third-quarter performance fell below market expectations for profit, sales, and profit margins, leading to a 9.3% drop in the company's stock price. This result prompted a series of target price downgrades.

The problem facing the bulls is that even though valuations have declined since July, the price-to-earnings ratio of the Nasdaq 100 index is still far from its low point. The current P/E ratio of the index is slightly below 22, but still much higher than the bottom valuation of around 19 in October last year, when the yield on the US 10-year Treasury hovered around 5%.

Christian Mueller-Glissmann, Head of Asset Allocation Research at Goldman Sachs, said: "This is a combined result of weak performance by some large tech companies and renewed selling pressure on the back end of bonds. Ultimately, stock risk premiums are at multi-year lows, further compressed since the start of the bond sell-off in the summer, leaving little room for further rate hikes and disappointing returns."