Results of tech giants shot through the roof
Results of tech giants shot through the roof
Stock markets have spent the early part of the year hovering cautiously on the threshold of a critical earnings season.
In this post, let's talk about expectations for the upcoming Q4 earnings season. The performance of tech giants like NVIDIA is expected to shoot through the roof in the coming years. Otherwise, the recovery from the downturn is stickier in the US. Let's also look at the upcoming earnings season in Finland. But to start with, I have a few words on the latest inflation data.
Inflation continues to persist, but the market calls for rate cuts
Last week's inflation data from the US was slightly hotter than expected, but the market doesn't care as investors wait for inflation to cool more this year. Overall prices rose by 3.4% year-on-year in December. However, the US 10-year bond rate, which reflects longer-term economic and inflation expectations, fell below 4%, and the stock market reaction to the disappointing data was not great either.
The stock market and stock prices are focused on inflation easing, Fed rate cuts and avoiding a recession.
Looking under the hood, the data didn't get any prettier. So-called "super core" inflation, i.e., inflation in services excluding slowly updating shelter costs, is still hovering at 0.4% month-on-month and 3.9% year-on-year, well above the Fed's 2% inflation target.
This signals that inflation is still awkwardly persistent in labor-intensive sectors. This - of course - fuels calls for wage increases, which in turn fuels inflation. That's why so much attention is focused on this inflation in the services sector. Wage growth is outpacing inflation, so real earnings in the US are developing very favorably, stimulating the economy. If this trend continues, inflation returning as a thorn in the side is a distinct possibility.
It’s good to note, however, that it’s the service sectors that will be affected by inflation. Commodity price change has been negative for some time now, so consumer goods are getting cheaper, for now. How long this trend can last in a strong economy, only time will tell.
The market still expects the Fed to make five rate cuts this year, possibly starting as early as March. This hope is not entirely unfounded. After all, the Fed has been indirectly turning the tables on liquidity for some time now, as I have talked about in my posts since the end of 2022. The Fed's net liquidity has been improving for almost 18 months, supporting stock markets and speculative asset classes such as gold and speculative cryptos.
However, interest rate cuts do not depend on inflation alone. Developments in the labor market also affect the policy rate. For example, in the 1990s, the Fed policy rate remained above 5% even as inflation fell to 2%. However, the Fed was then concerned about the overheating of the economy, with the unemployment rate falling steadily. This is only a guess, but it may be, referring to a point I made in my previous post on the weakening labor market, that the market expects the labor market to cool down just in time for the Fed to cut rates. Thus, the market's interest rate cut optimism wouldn’t be entirely unfounded.
One area of recent inflationary fears has been the Red Sea, where Iranian-backed Houthi rebels, in a curious show of empathy for the Gaza conflict, have fired missiles at cargo ships, disrupting a globally important logistics hub. 30% of the world's container traffic passes through there. Danish container shipping giant Maersk has steered its ships around Africa. Indeed, the international container price index has suddenly doubled like during the COVID pandemic, fueling fears of a new wave of inflation. Among others, Tesla announced that it would halt production in Germany for a couple of weeks due to a shortage of components. However, time will tell whether this will become a bigger mess as the logistics chains adjust and the rebels run out of missiles.
In any case, this is a good example of the vulnerability of the global economy, with pockets of conflict smoldering around the world. If inflation were to make a surprise comeback and interest rates were to rise again, there could be room for correction in the valuations of technology stocks, which have risen again.
Earnings season in Finland: There, dividends in
In Finland, the earnings season starts unofficially with the Q4 report of Admicom on Friday. On Nasdaq Helsinki, the Q4 earnings season is the most important of the four. For many companies, the results are concentrated at the end of the year. At the end of the financial year, companies give their outlook and guidance for the one ahead. With Europe, the key market for Nasdaq Helsinki, grumbling on the brink of recession and investment-driven China not pulling its weight, comments from listed companies on possible green shoots would be welcome. Naturally, the comments from companies also have a big influence on analysts' and investors' expectations of what is to come.
In addition, companies report how much money they intend to transfer from their accounts directly to shareholders' pockets in the form of dividends. After all, dividend yields on the stock market are high when share prices are low and companies' dividend payout capacity is still strong.
In absolute terms, Nasdaq Helsinki’s euro-denominated earnings pot shrinks as forestry companies and Fortum report lower profits. The average listed company's earnings are still expected to grow by 8% when looking at the median earnings growth of around 150 companies monitored by Inderes. At the same time, turnovers will fall slightly. This means that profitability would improve.
This contradiction sums up the current developments on the stock market front. The demand situation in both the Finnish and global economy is weak, which is why companies' sales are not growing. However, the worst cost pressures are easing, and companies are cutting costs to improve profitability. Although the stock market has its share of indebted rascals, the balance sheets of listed companies are, on the whole, sound.
Well, one earnings season is virtually irrelevant in the big picture. More relevant is how this short-term checkpoint on the state of companies affects perceptions of their long-term value-creating capacity. Inderes estimates that average results would increase by around 10% in 2024. This 10% is the standard level to start from at the beginning of the year, until the rougher reality tends to trim expectations. However, the growth rate of the results is supported by the recovery from a weak comparison period.
In a weaker economic environment in 2018-2019, EPS grew by an average of 5% per annum. In 2021, the hottest year of the COVID bubble, growth landed at over 20%. In this sense, Inderes' forecasts for this year, and especially for 2025, when earnings growth of almost 20% is expected, seem quite optimistic. It's worth being careful with them.
Earnings season in the US: Earnings turnaround continues
The Q4 earnings season should generally continue the turnaround that started in Q3. This would fit well with the script of stocks bottoming in fall 2022 in anticipation of a turnaround in earnings a year later.
The analyst consensus expects a cautious earnings growth of around 1%, depending a little on the source. Be that as it may, earnings growth expectations were still over 6% in October, when the previous earnings season was still ongoing, so the bar has been lowered even more than usual. Generally, earnings growth is always above analysts' lowered expectations.
Below the index level, the differences are huge. EPS for a tech giant riding the AI boom like NVIDIA are expected to jump from less than a dollar to $4.5 per share in the fourth quarter. In general, the results of technology companies are expected to grow by 20-40%, while many sectors will see their results decline.
Earnings growth will be held back in particular by banks, whose results are expected to normalize by a fifth from their previous record levels. JP Morgan, Wells Fargo, Bank of America and Citigroup, the giant banks that posted results last Friday, all reported fundamentally strong earnings. The largest bank, JP Morgan, still posted a record full-year profit of $50 billion as interest rates rose, and collectively the largest banks made a net profit of more than $100 billion last year. But the Q4 result itself was weighed down by billions in deposit insurance premiums related to the collapse of Silicon Valley Bank last year. The amount of credit losses also increased by a notch, rising to more than $6 billion. Payment problems are particularly acute for car loans, which coincides well with the credit data released by the New York Fed (last updated in Q3). However, bank executives joined in a chorus of reassurance that the consumer remains strong and that the increase in credit losses is more a matter of normalization after a period of unusually low losses during the pandemic. Overall, analysts expect the S&P 500’s performance to accelerate to over 10% growth in 2024.
It's noteworthy that the results of the index seem to be particularly driven by Big Tech. According to Yardeni Research, the 8 tech giants such as Microsoft, NVIDIA, Apple, and Meta will inflate their results by ~20% this year. Mega tech companies, which enjoy delicious profitability and countless cash flow reinvestment opportunities, are expected to deliver annualized earnings growth of up to 40% over the next 3-5 years. This is a staggering figure, because a 40% annual growth over three years would mean a 170% increase in earnings. However, compared to fiscal year 2022 or 2023 (some companies have different fiscal years), NVIDIA's earnings are expected to increase tenfold by 2026. Amazon is expected to increase ninefold. Meta to almost triple. The big jump in results is partly explained by the scaling of profitability.
As recently as last year, the earnings growth forecast for the tech giants was 15% the next few years, but now the forecasts are going through the roof.
The forward-looking P/E ratio of the S&P 500 index is around 20x, but excluding Big Tech it is just under 18x. In contrast, you have to pay 28 times forward earnings for the stocks in this group. It's not necessarily a bubble, but it's not cheap either.
Tech giants account for about a fifth of total S&P 500 earnings, so at highly priced index levels, this earnings improvement had better come through.
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