Is the Tech Sell-Off the Market’s Tipping Point?
It’s been a while since investors have seen the kind of volatility the markets having been showing over the past couple of months. The broader averages have toppled from earlier highs reached back in September, but then bounced back somewhat in the past few weeks. As with most market corrections, earnings results have been one of the largest sources for the uncertainty.
Earnings from big tech names like Apple, Facebook, and others surprised investors in a bad way last month. Lowered guidance and poor earnings results shook markets instigating a steep sell-off across all economic sectors. As a cyclical sector, the unexpected drop has many investors nervous about where the market may be headed.
The power of corporate earnings
Stocks are valued based on the expected future earnings stream of a company. That means that analyst’s reports and company guidance play an important role in determining what price a stock should be trading at. It also means that corporate earnings drive the stock market – positive earnings mean stock prices move higher while lowered expectations will drive them down.
One of the most-looked at valuation ratios for investors is the price-to-earnings (P/E) ratio. For example, a stock that reports annual earnings of $1.00 per share and trades at $20 per share will have a P/E ratio of 20. If earnings drop to $0.75 per share, the stock price must retreat to $15 per share in order to stay at the same valuation. If the price remains unchanged, the P/E multiple jumps higher to roughly 27 – a more expensive valuation with more implied risk.
Companies report earnings on a quarterly basis marking four separate earnings seasons throughout the year. While the 4th quarter is usually given more importance as it wraps up the year, any quarter that has widespread disappointment can have a detrimental effect on the markets. For the tech sector, normally a cyclical sector that performs well in a bullish economy, a bad quarter could be seen as a sign that the economy is slowing down.
Investors should note that quarterly earnings numbers shouldn’t always be taken at face value. Companies can manipulate earnings results through actions such as share repurchases which lower the total number of outstanding shares making earnings numbers appear higher than they actually should be if all things remained the same.
A sell-off in one industry doesn’t necessarily indicate the beginning of a bear market. A number of things need to happen in order for a broad market correction or reversal to a bear market. What the tech industry is telling investors right now is that they should be paying close attention to how other cyclical industries are doing. Economic reports like inflation and unemployment are indicators of where the market may be headed next as well. Investors should also keep a watch for large share repurchases – this may be a way for companies to delay reporting falling earnings in order to keep the stock price as high as possible for as long as they can.