The market appears to be reevaluating its position on the big technology stocks, with the trend becoming even clearer after Thursday’s quarterly releases from Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), and Facebook (FB). The market’s reaction to the Microsoft (MSFT) release a few days earlier is in the same category.

Since these technology companies have been some of the best performers lately, particularly since the market’s March bottom, weakness in these stocks is weighing on the market as a whole. Related to this is the issue of market concentration, with these big technology stocks accounting for a substantial part of the market’s rebound from the Covid-driven sell-off. Let’s try to unpack some of these issues here.

The composition of the stock market, using the S&P 500 index as a proxy for the market, has undergone a fundamental shift in recent years. This in turn is a reflection of the changes in the broader U.S. economy, with a fast growing and extremely dynamic Technology sector seeping into every nook and cranny of the economy.

The net effect of these compositional changes is that the Technology sector is by far the biggest contributor of earnings to the S&P 500 index, handily eclipsing the Finance sector, which enjoyed the biggest earnings weightage in the index for many years. The chart below plots the earnings contributions of the Zacks Technology and Finance sectors since 2002, with the Energy sector thrown in the mix to further emphasize the aforementioned compositional change.

As you can see here, the Technology sector (green line) is on track to bring in 28.8% of the S&P 500 index’s total earnings in 2021, with Finance accounting for 20.1% and Energy less than 2%.

Not only is the Technology sector bringing in the most money, it also enjoys the best earnings growth profile, as the chart below shows.

Please note that while Tech earnings are on track to decline -3.2% this year, the Finance sector and the broader index are expected to see 2020 earnings decline by -24.3% and -19%, respectively.

The growth outlook is even more impressive for the big Tech companies that we started this discussion with – Apple, Microsoft, Alphabet, Amazon and Facebook.

The table below shows that combined earnings for these 5 big companies are on track to increase by +7.6% on +12.3% higher revenues this year, followed by +25% earnings growth and +17.2% revenue growth in 2021.

For a company the size of Apple to be increasing its earnings by +24.3% in 2021 and +9.3% in 2022 is impressive anyway you look at it. The growth figures for Amazon are in a different world altogether.

I am not making a valuation comment here, just discussing earnings. Valuation is like beauty, it is in the eyes of the beholder. That said, there can be legitimate concerns that valuation for some of these Tech stocks may have gone a bit too far, particularly following the group’s impressive run up this year. More likely, the sell-off in these companies is simply profit taking, with market participants cashing in some of their profitable chips.

In other words, there is nothing fundamentally wrong with these stocks. If anything, the long-term outlook for these companies remains extremely favorable.

Tech Sector Scorecard

For the Tech sector, we now have Q3 results from 79.7% of the sector’s market capitalization in the S&P 500 index. Total earnings for these Tech companies are up +10.6% from the same period last year +5.8higher revenues, with 95.3% beating EPS estimates and 90.7% beating revenue estimates.

The comparison charts below put these results in a historical context and go some ways towards showing how the sector’s Q3 results are better relative to what we have been seeing in other recent periods, including pre-Covid quarters.

The first set of comparison charts is of the Q3 earnings and revenue growth rates.

The second set of comparison charts shows Q3 EPS and revenue beats percentages in the context of recent history.

Looking at Q3 as a whole, total Tech sector earnings are expected to be up +8.8% from the same period last year on +6.7% higher revenues. The chart below shows the sector’s Q3 earnings and revenue growth expectations in the context of where growth has been in recent quarters and what is expected in the coming three periods.

Q3 Earnings Season Scorecard (as of Friday, October 30)

We now have Q3 results from 320 S&P 500 members or 64% of the index’s total membership. Total earnings (or aggregate net income) for these 320 companies are down -7.2% from the same period last year on -4.3% lower revenues, with 86.6% beating EPS estimates and 77.8% beating revenue estimates.

The two sets of comparison charts below put the Q3 results from these 320 index members in a historical context, which should give us a sense how the Q3 earnings season is tracking at this stage relative to other recent periods.

The first set of comparison charts compare the earnings and revenue growth rates for these 320 index members.

The second set of charts compare the proportion of these 320 index members beating EPS and revenue estimates.

As you can see above that not only is the pace of declines decelerating, but also a much bigger proportion of companies are beating EPS and revenue estimates.

We have another super busy reporting docket this week, with more than 1100 companies reporting Q3 results, including 127 S&P 500 members.

Looking at Q3 as a whole, combining the actual results that have come out with estimates for the still-to-come companies, total earnings for the index are expected to be down -10.5% on -2.8% lower revenues. The key factor from the market’s standpoint is how estimates for 2020 Q4 evolve as companies report their Q3 results. The trend thus far is positive, as the chart below shows.

The chart below takes a big-picture view of the quarters, showing Q3 earnings (green bars) and revenue (Orange bars) growth in the context of what was actually achieved in the last few quarters and what is expected in the coming periods.

The chart below presents the big-picture view on an annual basis. As you can see below, 2020 earnings and revenues are expected to be down -19% and -4.4%, respectively.

The above annual growth picture approximates to an index ‘EPS’ of $126.83 for 2020, down from $156.53 in 2019 and $156.63 in 2021.