The way Info Tech stocks outperformed the market over the last three months, investors might be expecting the sector’s Q1 earnings growth to be sky high. That won’t necessarily be the case, however, if analysts have things pegged right.
Info Tech firms, on average, could see a slight-to-moderate year-over-year earnings decline, depending on which research firm you consult. Many reasons come to mind, including slowing sales in parts of the semiconductor chip sub-sector, a bit slower (though still strong) growth in cloud computing amid increasing competition, and weaker iPhone performance from Apple (AAPL).
Info Tech firms also enter Q1 earnings season facing some of the same issues as other S&P 500 sectors, including tough comparisons to year-ago performance, as well as a stronger dollar and a declining boost from the late 2017 U.S. tax reform that gave many companies a big spark in early 2018.
A couple of companies reporting in March set the stage. Oracle (ORCL) and HP (HPQ) appeared to disappoint investors, at least judging from their stocks' reaction to earnings and guidance from the two firms. The Info Tech reporting seasons kicks off in a major way the week of April 22 (see more below).
China Exposure Could Be Critical
Like a lot of sectors, Info Tech has a wide exposure to the Chinese market, so it wouldn’t be surprising if some companies saw an impact from the U.S./China trade battle and China’s slowing economic growth in Q1. It might be interesting to hear what some key executives like Tim Cook of AAPL and Satya Nadella of Microsoft (MSFT) have to say in their conference calls about any impact the trade situation is having on sales and projections.
Apple—still the elephant in the room when it comes to Info Tech—already shook things up ahead of earnings season with reports that the company cut iPhone prices in China as it faces fierce competition and falling demand for its iconic product there. Many analysts see AAPL transitioning to a more service-oriented model, and the company’s announcement late last month about new streaming products like Apple TV+ might have helped shares. Apple has been one of Wall Street’s better performers in Q1, but shares are still a long way from the all-time highs posted last fall.
The venerable AAPL wasn’t the only Info Tech company whose shares were living large in Q1 after a disappointing 2018. It’s shades of 2017 so far this year, as Info Tech led all sectors with blistering 22% gains through late last week, compared to around 14% for the S&P 500 (SPX). The Fed’s newfound dovish stance after a series of 2017 and 2018 rate hikes appears to have investors feeling optimistic about the stock market again, and when they feel that way they often gravitate toward Info Tech.
Much of the sector’s strong showing in Q1 probably reflected a market that’s looking ahead, not behind. The stock market sometimes takes on the role of being a leading indicator, skating toward where investors think the puck is going to be rather than where it is now. There’s growing hope for earnings improvement in Info Tech and other sectors throughout 2019, and U.S. economic growth is also generally expected to improve as the year continues after a tepid Q1 performance, according to many analysts.
The question now isn’t so much whether investors are enthusiastic or not about Tech, but more about whether demand for the industry’s widest-selling products can continue to justify the booming sector performance in Q2 and beyond. That likely means earnings season approaches with high investor expectations for Info Tech company guidance, meaning it’s possible companies that disappoint with their outlooks could get punished in the market.
Chips Take New Leadership Role
Two years ago, the so-called “FAANG” stocks, (which include AAPL, Alphabet (GOOG) and several other Internet names), led Info Tech to better than 30% gains for 2017. However, most of the FAANGs got split off from Info Tech into the new Communication Services sector several quarters ago, so when people talk Tech now, it’s not about the FAANGs. Increasingly, the faces of Info Tech tend to be chip makers like Intel (INTC) and Micron (MU), along with cloud-computing giants like Microsoft (MSFT) and Oracle (ORCL).
It looks like chips might have taken up FAANG’s former position as a market bellwether, providing momentum across the Info Tech sector and even into the rest of the S&P 500 when they look healthy, but spreading softness when they hit a road bump. Last fall, chip companies started warning of slower product growth, and that appeared to spook many investors. While there were many reasons for the Q4 Info Tech plunge, worries about declining chip demand can’t be overlooked.
As Investor’s Business Daily noted in a recent article, semiconductors provide the ingredient technologies for personal computers, tablets, smartphones and other gadgets. They run communications networks and the Internet, and are underpinning so-called “smart” technology improvements to televisions, home appliances, automobiles and other devices.
Trends like cloud computing, 5G wireless networks and artificial intelligence also depend on semiconductor chips. So arguably, if there’s a hitch in the semiconductor market, it could be a “canary in the coal mine” for much broader problems that go way beyond the semiconductor industry itself.
Semiconductor stocks are up about 27% year-to-date, outpacing the Tech sector as a whole. It appears the market is hoping for a big pick-up in earnings growth and order demand for the chip sector of Info Tech in Q1, Briefing.com noted, adding that investors are likely to closely watch chip makers’ guidance to see if CEOs confirm the market’s assumptions that a cyclical bottom is taking shape.
Current industry analysis suggests 2% to 3% growth in revenue this year and next for the chip industry. Memory chip sales are on pace to decline this year, while other segments should offset the shortfall, Investor’s Business Daily said.
Q1 Earnings Season
On the whole, Q1 earnings for the Info Tech sector are expected to fall 1.3%, according to research firm CFRA. That makes Info Tech one of seven sectors where CFRA predicts a negative overall earnings performance in the quarter.
FactSet is even more negative, expecting a 10.6% drop in Q1 Info Tech earnings performance, a much worse outcome than the 3% decline for the sector it had predicted back in late December. FactSet expects Info Tech revenue to fall 1% in Q1.
It’s quite a change from 2018, when Info Tech earnings rose 23.9%, and from Q4, when they rose nearly 12%. For the full year of 2019, CFRA sees the sector’s earnings coming in flat, compared to a 2.2% projected rise for the full spectrum of S&P 500 earnings.
However, as Briefing.com notes, a kind of broad-stroke thing to keep in mind with Tech is while earnings growth overall doesn’t look so swell for the sector, many individual companies have stronger earnings growth potential than in other blue chip areas. Arguably, the onus on companies whose shares had huge runs in Q1 is to live up to expectations that they can deliver even in a slower economy.
Upcoming Earnings Dates
The Info Tech earnings season begins in earnest the week of April 22, when some of the companies Briefing.com projects to report include United Technologies (UTX) and Texas Instruments (TXN) on April 23. Intel (INTC) and Microsoft (MSFT) are expected to report the same week.
Apple (AAPL) says it will be presenting its fiscal Q2 results on Tuesday, April 30, after the close. Some of the key chip makers won’t be reporting until mid-May or June.
TD Ameritrade® commentary for educational purposes only. Member SIPC.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.