LDN - Business

As U.S. megacaps soar, some investors are wary of rising valuations

[April 28, 2023] By Lewis Krauskopf

NEW YORK (Reuters) - Some market participants are warning that the U.S. market's biggest tech and growth stocks may be getting too expensive, even as better-than-expected earnings reports stand to further boost their appeal.

The Nasdaq 100 has rallied 19% this year, while four stocks that alone have a 40% weight in the index - Apple, Microsoft, Google parent Alphabet and Amazon - have posted an average gain of about 27%. That compares to a roughly 7% rise for the S&P 500.

Those gains have ramped up valuations: the price-to-earnings gap between the Nasdaq 100 and the S&P 500 recently hit its widest since early 2022, with the Nasdaq 100 trading at a P/E of 24.5 times versus 18.4 times for the S&P 500.

Valuations look even more expensive relative to history, given that interest rates were at rock-bottom levels during most of the past decade but soared last year as the Federal Reserve hiked rates to fight inflation. Tech and other high-growth companies generally are expected to bring in bigger profits in the future, but those projected cash flows are worth less in current dollars when interest rates rise.

“I am not sure that from a long-term perspective (buying tech stocks) is the appropriate decision,” said Paul Nolte, senior wealth advisor and market strategist at Murphy & Sylvest Wealth Management.

Nolte is underweight the tech sector, partially due to concerns about valuations and the expectation that the Fed will keep rates high to fight inflation.

Microsoft, Alphabet and Facebook parent Meta Platforms have reported better-than-expected earnings this week. Amazon will report after the close on Thursday, while Apple is due next week.

The better-than-expected financial numbers have helped justify the sharp rebound in megacap shares this year after a rough 2022. The rally has been driven in part by investors betting the companies’ strong business models would see them through an increasingly shaky economic environment.

Others, however, are more skeptical.

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Traders work on the trading floor at the New York Stock Exchange (NYSE) in New York City, U.S., March 17, 2023. REUTERS/Andrew Kelly

“It is an interesting market when a $2.2 trillion company with low to mid-single digit growth is awarded a multiple in excess of 30x earnings,” wrote Michael O’Rourke of Jones Trading on Wednesday’s rally in Microsoft shares, which rose 7.2% after their results beating revenue and profit estimates.

Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management, noted Meta Platforms saw “significant year-over-year declines in earnings per share.”

Shares of Meta were up 15% on Thursday and have roughly doubled year-to-date.

“It's tough to be impressed by companies exceeding already beaten down earnings estimates,” he wrote. “We would not be buyers of big tech stocks, which are extremely overvalued.”

Analysts at UBS Global Wealth Management, meanwhile, said gains in megacap stocks - which are heavily weighted in the S&P 500 - are unlikely to continue sustaining the broader index, noting that the current valuation for the S&P 500 has historically been maintained when earnings expectations were rosier and bond yields were lower.

Of course, concerns regarding tech stocks have been prevalent for months, yet have not stopped investors from piling into what fund managers in a BofA survey named as the markets most crowded trade.

King Lip, chief strategist at BakerAvenue Wealth Management, believes the stocks can rally further, if concerns over economic growth intensify in coming months.

“I do think even in a challenging environment, which likely we are going to be going into, that people are going to look at the megacaps as a place ... to play defense,” he said.

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Nick Zieminski)

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