The second quarter: Start of a tech unwind, or another run at historic highs?
The first quarter started euphorically, with stocks at historic highs in January, but ended in confusion. First it was inflation fears in February, then tariffs and trade wars in March. Worries about big tech came at the end, making it the first down quarter since September 2015.
Opinions are divided about the markets in the second quarter. There are two key facts to keep in mind: The is only 7 percent off its historic highs, and earnings are expected to grow 20 percent in the first quarter, and continue along this path for the rest of the year.
In case you're not familiar with earnings growth, 20 percent is a huge number. Not surprisingly, the long-term average yearly increase in the S&P 500 is about 7 percent.
The lesson: stocks tend to track future earnings expectations over the long term.
Earnings growth of 20 percent is practically unheard of, particularly after such a bull run. "I have never seen this much strong earnings growth this late in the earnings cycle," Nick Raich, who tracks earnings under The Earnings Scout moniker, told CNBC.
But the earnings outlook is being overshadowed by concerns in technology. Facebook, Google, Apple, Amazon and Twitter, as well as Tesla, all weighed on the markets in March.
Raich agrees, to a point. "The overall market is not overvalued, but certain tech is overvalued," he said, pointing to semiconductors and semiconductor capital equipment stocks as one group that could pull back.
The size of the technology space has become an issue for the trading community. Technology is 25 percent of the weighting in the S&P 500, far and away the biggest sector. The big five technology stocks — Apple, Alphabet, Microsoft, Facebook and Amazon (Amazon is technically categorized as a consumer discretionary stock) — together account for 15 percent of the entire S&P 500.
And the earnings expectations around technology are similarly outsized. Technology and financial earnings in the first quarter are expected to be almost double the rest of the S&P 500.
Tech: up 23 percent
Financials: up 24 percent
Industrials: up 15 percent
Cons. Staples: up 10 percent
Consumer Disc: up 9 percent
Source: Thomson Reuters
It's little wonder that the market goes into a tizzy when there is even a small threat to technology earnings expectations. And the threat is not small. The existential crisis with Facebook and social media, regulatory worries and technology issues around driverless cars (an issue for the semiconductor sector) all have the potential to move the needle on earnings.
Raich is optimistic about earnings as well as earnings guidance for the full year. Part of his optimism is based on the strong trends he has already seen. So far, 19 companies have reported earnings for the first quarter (these tend to be companies that ended their quarters in February).
The results are far above expectations. The 19 companies had 31 percent earnings growth, and an astonishing 12 percent revenue growth.
It was, Raich said, the best start for those early companies in 20 years. "And this growth is not just coming from share buybacks," he said. "We are getting top-line growth."
When will this end? Earnings are still seen rising in the second, third and fourth quarters. Surprisingly, they have been going up almost every week in 2018.
His "tell" for a slowdown is what he calls the "delta" — the rate of earnings growth slowing down.
"When earnings growth starts to slow down, you know you're near the top," he told me.
He anticipates that may happen toward the third quarter.