Market Update: Big tech stocks increase is ‘artificial’

Last week we wrote that markets were facing growing risks. Since then, and at the time of writing, equity markets have generally headed higher. Japan has been enjoying a particularly good run with the Nikkei 225 making gains every day since last Wednesday. This has occurred despite some disappointing economic data and a weakening currency (we’ll return to the currency moves in a moment). However, the most notable moves have been in US stocks, with the large-cap tech names doing very well in aggregate.

The earnings reports for Q1 have almost all been published, and have surpassed the usual ‘better-than-expected’ level. We all know companies manage to ‘beat’ the near-term expectations of bottom-up analysts, sometimes at the expense of the next quarter’s forecasts. However, on a market-cap-weighted basis, developed world stocks have seen a return to earnings growth in the forecasts for the next 12 months. That’s after six months of analysts seeing falls in earnings.

In Europe, HSBC analysts note that cyclical sectors have been the winner while real estate has been the laggard. They see a swing in momentum and their forecasts have improved through the late part of the earning season to about an 8% annualised growth rate. Still, the 2023 forecast as a whole is muted at just 1% compared to 2022. Companies continue to be hit by higher interest rates and HSBC is concerned that the European Central Bank (ECB) may keep tightening financial conditions through the summer.

In the US, retailers have been discussing the continued softening of spending trends for big-ticket and other discretionary items. The pandemic reversal is till releasing pent-up demand for services, though, particularly when it comes to travel and entertainment.

But for both regions, what stands out as surprising is that ‘top-line’ revenues are better than expected. In Europe margins are still under pressure, but sales are substantially improved. In the US, both sales and margins have started to improve. That tallies with a more stable economic environment, especially for Europe where energy price declines have helped greatly. The improvement in global service sector purchasing manager indices (PMIs) also helps explain the corporate positivity. Meanwhile, Goldman Sachs notes that three themes have dominated earnings calls: banking stress, returning cash to shareholders, and artificial intelligence.

Exposure to regional banks and potential impacts on credit availability remains a focus for mid-caps and smaller companies. Most continue to want to pay back cash through share buybacks and dividends, although financials appear less keen.

Artificial intelligence (AI) is the hottest of topics. Although potentially encompassing many different aspects, most companies are talking about the use and development of chatbot (large language model engine) applications. Management teams talk about the potential business impact, current uses and plans for investments. Here there’s a split. For some service companies, AI is a threat because, for the customer companies, it offers a great opportunity to cut costs. But, as Goldman Sachs noted in a discussion yesterday, there are few companies for whom AI represents a direct profit opportunity. Goldmans suggests the main winners are hardware manufacturers at the cutting edge of fast computing, followed by the software techs that have investment capital – at least $1 billion in to put into research and development. And then you still need access to huge proprietary data.