Tech lives up to the hype as US GDP paints a mixed picture

Amazon has just reported its results for the first quarter, and they impressed the market. The online retailer and cloud computing giant has seen its share price jump 9% in after-hours trading on Thursday after rising more than 4.6% during Thursday’s session in expectation of a decent set of results. Like Facebook, Amazon has managed to significantly beat expectations, and is also pointing to a stronger than expected Q2. With some of the US’s largest companies revising up their expectations for the second quarter, we expect to see some significant earnings upgrades across the broader S&P 500 space, and earnings upgrades usually mean higher stock prices.

Bulls in charge as we move towards May

It is no surprise that the S&P 500 rose nearly 2% on Thursday, while the tech index rose more than 2.7%. Meta, the Facebook owner, saw its share price rise by nearly 14% on Thursday, and gains are expected to be extended into Friday. However, we would note that this is a massive move, Meta’s share price has nearly doubled year to date, and is up some 95% since January. Added to this, Meta’s price to earnings ratio is more than 27, which is high, but below the 37 reached in August 2020. The question now is: is Meta and co. priced fairly? Based on earnings, we think that Meta’s share price is well-deserved, and there could be some further upside, however, there may be some trouble ahead.

Reasons to celebrate Meta results

Looking deeper into the Meta earnings, total operating profit was $7.2 bn, up 8% vs. analyst expectations, the operating margin picked up by 5% vs. Q4 2022. Facebook has also announced another round of layoffs, with Zuckerberg sticking to his efficiency mantra and cutting nearly a quarter of the workforce. Zuckerberg noted that headcount was above 77k for Q1, however, that doesn’t take account of the layoffs that are set to come this quarter. The market’s joyous reaction to these results wasn’t all based on the number of jobs that would be cut. Instead there was a very pleasant surprise from a 4% YoY boost to advertising revenue, which rose to $28.1bn, which is something to celebrate in an economic downturn. Added to this, Meta managed to add another 37 million active daily users, nearly 3 times what the market expected. Q2 expectations were also revised higher, with revenue expected in a range of $29.5bn to $32 bn, 5% higher than what analysts had expected the range to be.

Why Meta is not out of the woods yet

It wasn’t all good news, there are two things that we would point out that could scupper Meta’s share price rise. 1, Zuckerberg is still focussing on the Metaverse, and is now talking about integrating AI. However, Meta’s virtual reality business is expected to make a loss of $13.7bn this year, which is another sign that Zuckerberg’s innovation engine could also be a profit killer down the line. The second point that we would note is that the focus on job cuts could hurt morale inside Meta, and when this happens it can skew the company’s mission and innovation potential. Thus, Zuckerberg needs to manage these efficiencies carefully from now on. Finally, now that Meta has revised up its Q2 revenue guidance, can it beat expectations going forward and will it be able to sustain recent gains?

A low bar gets Amazon over the line

Amazon’s results also highlight how tech is back from the pandemic doldrums, which is why investor enthusiasm for big tech this year has been justified. First quarter sales rose by 9% YoY, and it posted profits of $3.2bn, which is 50% more than analysts had expected, Amazon also said that it had reduced its headcount by a further 10% in Q1 and had shut down some unprofitable units. Sales in the all-important Amazon Web Services slowed to 15.8%, which was higher than expected. The slowdown in sales was largely down to companies scaling back due to economic uncertainty, the question now is, will the economic outlook improve in Q2 and beyond, and is the nadir for web services that have suffered in recent months? Online store sales were flat, and prime membership growth has stalled after years of very fast growth. This may sound grim, but it is better than expected, and in Q2 that is what matters most.

US GDP: not as weak as it looks

As we have mentioned, the outlook for Amazon, which has seen its share price rise more than 28% so far this year, will depend on its web service business. If this can outperform it will depend on the economic outlook. US Q1 GDP was weaker than expected, it slowed to a 1.1% annualised rate, down from 2.6% in Q4 2022. This was a contrast to China, which saw growth rise more than expected, and even the Eurozone’s GDP rate managed to outperform the US, with a rate of growth of 1.4% YoY in Q1. However, 2-year Treasury yields rose nearly 13 basis points, and the expectations for a 25bp rate rise from the Federal Reserve next week rose back above 87%. This was down to the consumer spending element, inflation adjusted consumer spending rose some 3.7% on an annualised rate, a large increase from the 1% increase registered in Q4.

The risks of a strong consumer

As the jobs market has remained strong and wage growth robust, the US consumer’s confidence has returned. The plus side is that the engine of US growth looks like it is alive and well, while on the other side, it could make it harder for the Fed to control inflation and interest rates may need to rise further. If that happens then it could make the high valuations for the likes of Meta and Amazon look too rich, which could slow the stock market rally. However, that is unlikely to happen unless the Fed signals that a pause in rate hikes is off the table when it meets next week. If that happens then a stronger dollar, and weaker stocks could dominate the rest of Q2. As always, everything hinges on the Fed.