There Is Concern Over Rising Valuations Among U.S. Megacaps As They Soar

As part of an ongoing battle between market participants, a number of market experts believe that some of the largest tech and growth stocks in the U.S. market may be getting too expensive, despite the fact that the earnings reports were better than expected.

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A significant percentage of the Nasdaq 100 (.NDX) index has risen since its inception in January, but four stocks that alone have a 40 percent weight in the index, such as Apple (AAPL.O), Microsoft (MSFT.O), Alphabet's parent, Alphabet's parent company, and Amazon's parent company, Amazon, have posted gains of more than 27 percent. In comparison, the S&P 500 (.SPX) has risen by approximately 7% in the last year.

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The Nasdaq 100 recently traded at a price-to-earnings ratio of 24.5 times, whereas the S&P 500 trades at a price-to-earnings ratio of 18.4 times. Because of these gains, valuations have rocketed up; the price-to-earnings gap between the Nasdaq 100 and the S&P 500 recently reached its widest since early 2022.

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In terms of values, they seem even more expensive when compared to history. Interest rates were extremely low during the past decade, but they spiked last year as the Federal Reserve raised interest rates to fight inflation, which led to a rise in the price of the housing stock. In general, technology companies and other high-growth companies are expected to generate higher profits in the future, but when interest rates rise, those projected cash flows become less valuable in current dollars.

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According to Paul Nolte, a senior wealth advisor and analyst at Murphy & Sylvest Wealth Management, "From a long-term perspective, I am not sure that (buying tech stocks) is the right decision," he added.

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Due to expectations that the Fed will be able to maintain rates at a high level to fight inflation, Nolte's underweighting of the tech sector partially reflects his concerns about valuations.

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During this week's earnings report season, many of the companies have exceeded expectations, including Microsoft, Alphabet, and Facebook parent Meta Platforms (META.O). Amazon is scheduled to report after the close on Thursday, while Apple will report next Thursday.

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As a result of better-than-expected financial results, megacap shares have rebounded sharply this year after having had a tough year in 2022. Investors have backed the companies' strong business models as a means of coping with what is becoming an increasingly shaky economic environment, which is why the rally has been driven in part.

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There are, however, some who are more sceptical about this idea.

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In his article on Wednesday's rally in Microsoft shares, Michael O'Rourke of Jones Trading wrote, "It is interesting to see a company worth $2.2 trillion with low to mid-single-digit growth and a multiple greater than 30x earnings." After Microsoft's revenue and profit results exceeded expectations, the company shares climbed 7.2% on Wednesday.

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There was a significant decline in Meta Platforms' earnings per share year-over-year in its EPS, according to Landsberg Bennett Private Wealth Management's chief investment officer Michael Landsberg.

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A 15% gain on Thursday led to Meta's shares climbing roughly double in value for the year to date, up from just 6% a year ago.

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Despite the fact that companies continue to exceed earnings estimates that have already been beaten down, it is difficult to be impressed. Therefore, we would not be able to purchase stocks of large tech companies.

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Similarly, analysts at UBS Global Wealth Management have stated that the S&P 500 is unlikely to continue to be sustained by gains in megacap stocks, since those stocks are heavily weighted in the index. The S&P 500's current valuation has historically been maintained in past times when earnings expectations were rosier and bond yields were lower, which is why the current valuation of the S&P 500 is being maintained.

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While concerns regarding tech stocks have been prevalent for months, they haven't stopped investors from piling into what the Bank of America survey identified as the most crowded trade on the market, despite ongoing concerns over the stocks.

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It appears that BakerAvenue Wealth Management's chief strategist, King Lip, believes that the stocks can rally further if concerns about the economy intensify over the next few months and the outlook for growth deteriorates.

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The biggest problem with megacaps is that they are going to be seen as a place where you go if you are looking to play defense, even when you are in a challenging environment, as we are likely to be in those days ahead.