Rising Pressure on Profits Darkens Outlook for Tech Shares

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In early summer, I wrote a Tech Trader column previewing the June quarter earnings season, and advised investors to “brace for trouble.” Well, trouble finally has arrived. In bulk.

Admittedly, I was early. The Nasdaq Composite rallied 13% from the publication of that July 11 column through the market peak in mid-August. In that period, stocks benefited from softening interest rates and a widespread view that slashed September-quarter earnings estimates had positioned technology stocks for better performance.

But the summer rally is now just a memory, the gains have evaporated, and there are reasons to expect lower lows. I stand by my warning. And the situation has grown grimmer.

The most obvious change came with Federal Reserve Board Chairman Jerome Powell’s late July speech at the annual Fed economic conference in Jackson Hole. Heading into that eight-minute talk, the market had rallied on the misguided view that he would signal a softened stance on raising rates to fight inflation, given a recent reversal of fuel prices, rising retail inventories, and other signs of an improving picture on prices. But instead, he staked out a hawkish stance, declaring himself a determined inflation fighter, and warning that households and companies alike should brace for pain. Over the next few trading days tech stock prices declined, and interest rates ratcheted skyward, with the closely watched 10-year Treasury yield ratcheting up a quarter-point to 3.25%, the highest level since the market bottom in June.

Increasing interest rates spell trouble for stocks generally, and tech shares in particular. But that’s far from the only issue. I’m more concerned with the growing chorus of enterprise tech CEOs and CFOs warning about the outlook, slashing estimates and generally acknowledging that they aren’t going to escape the recession unscathed. OK, so maybe we’re not officially in a recession—declaring recessions is for some reason the job of the National Bureau of Economic Research, a private group of economists. But they’re being too slow.

Just ask

C3.ai

(ticker: AI) CEO Tom Siebel. A Silicon Valley legend best known for building Siebel Systems, once the leading player in customer-relationship management software, Siebel now runs a company focused on artificial intelligence software. This past week, C3.ai reported soft earnings for its July quarter, and provided guidance for the October quarter that came in well short of Street estimates. The day after, the stock fell 19%. Blame the economy.

“No question, we’re in a recession,” Siebel declares in an interview with Barron’s. “Our customers are in planning meetings, trying to figure out how they’ll operate in a recession. Did we see a slowdown in our business? Absolutely. And it accelerated in July.”

Siebel’s observation isn’t an outlier. Over the past few weeks, there have been a flurry of earnings reports from tech companies like C3.ai that have quarters ending in July, rather than June. And it appears the July quarter was worse than the June quarter.

The trend is not your friend.

Trouble is cropping up across the software sector.

Okta

(OKTA), which makes identity-management software, last week noted that it was “starting to notice some tightening of IT budgets and lengthening sales cycles relative to last quarter.”

Veeva Systems

(VEEV), which makes cloud-based software for life sciences companies, cut guidance, citing changes in the macroeconomic environment.

Samsara

(IOT), an internet-of-things play that sells software for tracking transportation fleets, posted strong earnings, but nevertheless reported “elongated sales cycles,” with higher levels of required deal approval to close transactions.

There are similar problems in hardware. It’s no secret that PC demand is sagging. In recent weeks

Micron Technology

(MU),

Western Digital

(WDC),

Intel

(INTC) and

Nvidia

(NVDA) have warned about softening PC demand. Right on cue,

Dell

(DELL) reported punk results two weeks ago, and there was vivid confirmation of the trend this past week from

HP Inc.

(HPQ).

In its July quarter, HP’s PC unit sales fell 25%, year over year, with a whopping 32% drop in notebook purchases. Why? HP CEO Enrique Lores says that commercial customers took a “more cautious, more measured approach.”

Alas, it isn’t just PCs. Dell CFO Tom Sweet a week earlier told Barron’s that his company is seeing buyers getting more cautious on enterprise hardware, in particular data-center servers and cloud-computing gear. This past week, disk-drive maker

Seagate Technology

(STX) said that since mid-July it has been seeing “weaker economic trends in certain Asian regions,” and “more cautious buying” by large companies, including “certain U.S. cloud customers.”

That’s alarming. Cloud computing has been one of the strongest parts of the tech sector, and just two weeks ago

Snowflake

(SNOW) surprised the Street with better-than-expected Julyquarter results. That followed strong growth in the June quarter from all three of the leading cloud players: Amazon Web Services, Microsoft Azure, and Google Cloud.

The warning signs are growing.

MongoDB

(MDB), a cloud-based database software provider, sees demand from some customers falling, as their own businesses slow. That indicates that AWS, Azure, and Google Cloud could post disappointing results for the September quarter or soon after. And the market wouldn’t like that.

So, we’re in a new phase of the valuation reset that started in November 2021. In the first phase, rising rates triggered lower valuation multiples. In this second leg, the issue will be crumbling earnings. Look out below.

Write to Eric J. Savitz at [email protected]