Big Tech earnings could bring a test of the concentrated equity rally

If earnings results from Tesla and Netflix are any signal of what to expect in next week’s big tech earnings, it may be time to get cautious. Alphabet and Microsoft report on Tuesday, followed by Meta on Wednesday. Netflix and Tesla did not massively underperform consensus expectations, but their announcements did not justify the recent run higher we have seen in their stock prices. 

Big tech has been a key driver of the recent rally in the key US indices this year, with Alphabet up 35% YTD, Microsoft up 44% and Meta up 150%. This significant run higher in big tech stocks would potentially need an outperformance over modest consensus expectations to justify the valuations. 

No doubt we will get another test of the AI theme as well that has been a key play in the markets this year. However, expectations on AI are likely to make a practical shift from hearing about intent to investing in AI being a key test in Q1 to evaluating the payoffs that can be generated from these investments being the potential test in Q2. Recent warning from TSMC has also started to take some of froth built in the AI space, and a key test lies in the weeks ahead.

Alphabet (GOOG:xnas)

• Reporting date: Tuesday, 25 July (after-market)
• Revenue estimate: $60.79bn (-12% YoY) vs. $69.79bn in Q1
• EPS estimate: $1.44 (+15% YoY) vs. $1.31 in Q1
• Valuation: Current P/E 24.6x, Forward P/E 17.8x
  
  

Microsoft (MSFT:xnas)

• Reporting date: Tuesday, 25 July (after-market)
• Revenue estimate: $55.49bn (+7% YoY) vs. $52.86bn in Q1
• Adj. EPS estimate: $2.55 (+13% YoY) vs. $2.44 in Q1
• Valuation: Current P/E 37x, Forward P/E 31.4x
  
  

Meta (META:xnas)

• Reporting date: Wednesday, 26 July (after-market)
• Revenue estimate: $31.08bn (+8% YoY) vs. $28.65bn in Q1
• EPS estimate: $3.06 (+24% YoY) vs. $2.78 in Q1
• Valuation: Current P/E 27.4x, Forward P/E 18.7x

Alphabet and Microsoft have been in a close battle on the AI narrative. Microsoft enjoyed the first-mover advantage in the generative AI space with the launch of ChatGPT. Microsoft has also launched 365Copilot, an AI enabled version of its widely used Microsoft Office 365 apps as it aims to enhance the enterprise AI solutions to maintain its lead. Meanwhile, Google parent Alphabet has years of research on AI to boast of despite losing some initial ground this year. Google also has the largest user data that can be used to make it AI solutions more effective, and a more reasonable forward valuation. With an improvement in the macro climate, advertising and cloud businesses may also see a pickup.  

Meta is somewhat less advanced on the AI front as of now, which leaves room for a surprise either at the earnings announcement or another time in the future. But with 150% gains YTD, expectations are likely running high. Some initial success from the recent launch of microblogging Twitter-rival Threads may provide a boost, but the early enthusiasm is seemingly fading. 

Overall, big tech has a tough task of not just meeting expectations, but also justifying the stretched valuations for the positive sentiment to continue. They could bring a make or break moment for the recent equity rally. Still, the cyclical macro themes of softening inflation and a potential end of tightening from the Fed (and other central banks) are supportive of further gains in equities. But any disappointment from the big tech earnings could mean a rotation into cyclicals and other quality stocks that have far more reasonable valuations.