Wall Street week ahead: Megacap gains to test nascent rally in US stocks

Wall Street week ahead: Megacap gains to test nascent rally in US stocks

NEW YORK, Oct 21 (Reuters) – Earnings reports from the four largest U.S. companies by market capitalization next week could test a nascent rally that has pushed stocks back from another low.

Apple (AAPL.O)Microsoft (MSFT.O)google main alphabet (GOOGL.O) and Amazon (AMZN.O) represent a combined 20% of the weight of the S&P 500 (.SPX) and more than a third of the Nasdaq Composite (.IXIC).

Investors see the growth giants as benchmarks for how corporate America is faring during a year in which inflation soared, prompting the Federal Reserve to quickly enact a series of giant rate hikes that hit markets and raised fears that a recession is looming.

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“If these megacaps can’t get it right, then the question is who can get it right?” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management.

Market value of major stocks as a percentage of the S&P 500

The S&P 500 is up nearly 5% from its year-end low on Oct. 12 after posting its biggest weekly gain since late June. Even with the latest stock rally, the index is down 21% so far in 2022, on track for its biggest drop since 2008.

Resilient corporate earnings have been a bright spot this year, though questions are growing about how sustainable they will be. With most of the S&P 500 companies yet to report, third-quarter earnings are estimated to have risen 3.1% compared to the same period a year ago, which would be the weakest performance in two years, according to Refinitiv IBES, while earnings growth expectations for 2023 have fallen to 7.2% from 7.8% on October 1.

Next week’s reports from all four megacaps may show whether companies with dominant positions can post a strong performance despite concerns of a potential economic downturn.

Because of their heavy weightings, “if those stocks don’t make it, that puts pressure on the indices to keep going lower,” said Chuck Carlson, chief executive of Horizon Investment Services.

Microsoft and Alphabet are due to report on Tuesday, with Amazon and Apple scheduled for Thursday.

Apple shares are the only one of the mega-caps to have outperformed the broader market this year. Shares of the iPhone maker, which accounts for a 7% weight in the S&P 500, are down 17% in 2022; Microsoft and Amazon are each about 28% off, Alphabet is down 30%.

Reuters Charts

Despite those heavy losses, investors have maintained exposure to mega-cap stocks. Actively managed US exchange-traded and mutual funds held 11.41% of their portfolios in those four stocks combined based on the most recently available data, up from 11.44% at the end of 2021, according to Morningstar Direct.

Investors have been attracted to large companies in general because of their financial strength and competitive advantages that, in theory, will boost earnings even in times of economic uncertainty.

Still, only Apple has beaten analyst estimates for profit and revenue in its two most recent quarterly reports, according to Refinitiv data.

“The bar is higher for Apple because it has outperformed and because it hasn’t seen earnings flicker yet,” said Walter Todd, chief investment officer at Greenwood Capital.

Questions hang over the other companies’ key market areas, including Microsoft’s personal computers, Alphabet’s ad spending and Amazon’s consumer strength.

All three rely on cloud computing businesses, which will be in the spotlight next week, according to Charlie Ryan, a partner and portfolio manager at Evercore Wealth Management.

“Cloud would be the pillar that one would pin their hopes on when reporting,” Ryan said. “It has been a continuing force for quite some time and any deviation from that would be a concern.”

Meanwhile, soaring US bond yields are putting pressure on valuations and complicating the outlook for technology stocks and other growth stocks, whose expected future earnings are heavily discounted by higher yields. Yields continued to rise this week, with the benchmark 10-year Treasury yield hitting a new 14-year high.

All four stocks have higher valuations than the S&P 500, which is trading at nearly 16 times future earnings estimates. The P/Es for Apple and Microsoft are roughly 22 times, Alphabet trades at 17.5 times, while Amazon stands at 60 times, according to Refinitiv Datastream.

“Those stocks have generally sold at earnings multiples that are on the higher side,” said Carlson of Horizon Investment Services. .”

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Information from Lewis Krauskopf; Edited by Ira Iosebashvili and David Gregorio

Our standards: The Thomson Reuters Trust Principles.

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