By Teresa Rivas
As third-quarter earnings season approaches, all eyes are again on big tech, as investor fret about the sector's high valuations and even higher spending on artificial intelligence. Yet it still looks like the best game in town.
The S&P 500 hit another record high on Wednesday, its 44(th) record close of the year, and both it and the Nasdaq Composite are up about 0.5% this month. However the Magnificent Seven tech stocks have had a more uneven performance.
While Nvidia and Facebook parent Meta Platforms are still markedly outperforming, the other five -- Google parent Alphabet, Amazon.com, Apple, Microsoft, and Tesla -- are having a tougher time. As of the start of the week, they were all trailing the S&P 500's 2024 gains. A more risk-averse attitude around the start of the month weighed on some tech firms, and in some cases, investors are still feeling jittery about when and how big investments in artificial intelligence will pay off.
That could explain why investors aren't more excited about the stocks heading into earnings season, particularly since expectations have gotten so high.
In fact, as DataTrek Research's Jessica Rabe notes, analysts' consensus estimates for the Magnificent Seven have rapidly risen, to the point that Wall Street now expects these companies to deliver double- or triple-digit revenue growth year over year, not only for the current quarter and year but next year too. Moreover, excluding Tesla, they are looking for double- or triple-digit earnings growth too.
Investors may worry that it will be hard to clear that bar. Other big chip stocks, including Broadcom, Advanced Micro Devices and Qualcomm, have also seen their multiples contract ahead of earnings, which could indicate that AI skepticism is growing. The market may have become "a little bit more fatigued on the AI theme," Gabelli Funds opined.
That's a fair concern, but it's still hard to bet against the M7 or big U.S. tech in general, given its long-term ability to outperform the broader market.
Capital Economics makes a similar point on Friday. According to the proprietary AI Economic Impact Index, which ranks major economies according to their ability to realize the benefits of AI, "the U.S. is still leading the AI revolution and will accrue the biggest productivity benefits," as Senior Economic Advisor Vicky Redwood writes.
That's down to the fact that the U.S. remains well ahead of other nations in terms of innovation, diffusion and adaptation, three key pillars the firm uses as part of its ranking. That contrast with Europe, where Capital Economics thinks that the pace of AI adoption will lag behind the rest of the developed world, and even China, which ranks only at 17(th) , which is hamstrung by the government's desire to keep a tight rein on Chinese firms and ensure AI complies with censorship rules.
As JPMorgan noted earlier this week, American exceptionalism is alive and well, as exemplified by its big tech firms' stellar growth, and while it may be concerned about the hype, there are few better alternatives: "It is not possible to know in advance what the $0.5-$1.0 trillion in annual AI capex and R&D spend will mean for products and services in 5-10 years. While we are concerned that AI growth is unlikely to meet new product and margin expectations, the wisdom of the crowd among corporates, strategy consultants, and VC investors is much more sanguine about the outlook."
And DataTrek's Rabe argues that while investor's nerves are understandable, there's reason to push through them. "These forecasts demonstrate analysts' conviction in the underlying fundamentals of these names. On the other, these are possibly aggressive estimates to beat and one reason why investors have looked away from Tech stocks and to classic cyclical groups for more earnings leverage and potential for upside surprises. Nevertheless, we still like U.S. large cap Tech through year-end given their strong cash flows and recent unusual underperformance."
In short, there are reasons for the recent caution around tech, but with the AI revolution still in the early innings, it's hard to be bearish for the long haul.
Write to Teresa Rivas at teresa.rivas@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
October 11, 2024 15:30 ET (19:30 GMT)
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