Investors Await Tech Earnings in Next Test for Markets

The companies’ heavy weighting in the index makes their next round of quarterly earnings especially important because any disappointment could leave the broader market vulnerable to a selloff. Microsoft reported sales of $52.7 billion and net income of $16.4 billion on Tuesday afternoon, and the other companies will follow in February.

“You care about these earnings even if you don’t care,” said Daniel Morgan, senior portfolio manager at Synovus Trust.

Expectations for the group aren’t high. Microsoft’s sales grew by 2% and its profit fell by 12% from a year ago. Analysts expect revenue growth of just 2% on average at the other three largest tech companies in the latest quarter, including a 1% decline at Apple. Profits are projected to decline at all three companies by an average of 39%, according to FactSet.

The pandemic fueled a sales boom in everything from iPhones to cloud-computing contracts, which sent stock prices soaring. Silicon Valley giants rushed to hire enough workers to keep up with surging demand.

But last year, the script flipped when the Federal Reserve embarked on its campaign to tighten monetary policy. Fears of a possible recession have grown just as the pandemic-era boom came to an end. Now, the prospect of tighter regulations also looms on the horizon.

“In this type of environment, companies are looking to constrain expenses, so some IT spending is likely to be reined in,” said Michael Walker, portfolio manager at AllianceBernstein. His fund owns Microsoft and Amazon shares.

Tech companies are sharply cutting staff after head counts swelled in the pandemic boom. Alphabet said last week it plans to eliminate 12,000 jobs, its largest-ever round of layoffs. Microsoft said last week it was cutting 10,000 workers, its largest round in eight years. Amazon.com and Facebook parent Meta Platforms Inc.

are also slashing thousands of jobs. Executives are sounding a more austere tone.

“We are going to go through a phase today where there is going to be a normalization of demand,” Microsoft Chief Executive Satya Nadella said last week. “We in the tech industry will have to get more efficient—it’s not about everyone else doing more with less, we will have to do more with less. We will have to show our own productivity gains.”

Early returns so far this year are encouraging. Alphabet stock has gained 11%, while Amazon and Meta have gained about 15% and 19%, respectively. Apple has risen 9.7%, while Microsoft stock is up about 1%. Still, those stocks are well below their record highs, despite the recent rally.

The sector has benefited from hopes that the Fed will soon reverse course on its tightening campaign. The 10-year Treasury yield recently closed at its lowest level since September. Tech stocks have historically performed well when bond yields are low.

Additionally, the dollar has weakened significantly of late, after the currency’s strength hampered companies with large overseas operations last year. The WSJ Dollar Index closed Tuesday at 95.09, down nearly 10% from last year’s peak in September.

The large weighting of tech stocks presents a fresh risk to index funds in a weaker operating environment, said Ryan Grabinski, investment strategist at Strategas Research Partners. “Those top stocks had been carrying their earnings weight for years,” referring to their share of profits matching their share of market value.

He added that the technology sector accounted for 26% of the S&P 500’s market value at the end of 2022, but contributed just 21% of earnings in the most recent 12 months.

“The risk now is that some of these business lines aren’t going to be earning what they’ve been earning,” Mr. Grabinski said.

The tech earnings season has started on a positive note. Netflix Inc.

shares rose last week after reporting results that topped the forecasts of Wall Street analysts. The company exceeded its own subscriber-growth forecasts and has said it would crack down on password sharing and launch an ad-supported plan.

Plus, tech stocks look more attractive after the steep selloff. Microsoft and Apple, for example, trade at under 26 times and 23 times trailing earnings, respectively. Both stocks traded above 40 times earnings in 2021, according to FactSet.

Bulls still see the business slowdown as a short-term problem for an otherwise attractive investment.

“I don’t see the total obliteration of the group like in 2000,” said Mr. Morgan. “We may head into a mild recession, but a lot of these technologies are here to stay and they’re proven.”

Write to Charley Grant at [email protected]