(Bloomberg) — Looking for a unifying theory on what’s ailing equities in a world of vacillating bond yields, iffy earnings and mixed messages from the Federal Reserve? Try valuations.
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That they’re too high, in short, bloated by the relentless seven-month ascent in a handful of artificial-intelligence super stocks. What else explains how earnings missteps at Tesla Inc. and now Alphabet Inc. morphed into more than 9% single-day selloffs in the span of a week? For Google’s parent company, it was the second worst post-earnings selloff on record.
Fixed-income stress and macro uncertainty are in the mix — poor demand for Treasuries is pushing up yields as growing supply worries bond traders — but the accelerant on days like Wednesday is lofty price.
“Companies have been priced for perfection,” said Michael O’Rourke, chief market strategist at JonesTrading. “They are ripe for a sharp selloff on any sign of weakness.”
It’s an oft-told story of the rapidly vanishing stock-market surge. Since earnings and estimates held steady while shares were going up, the whole rally was a function of people ponying up more money for the same slice of profits. Now, with 5% Treasuries coaxing the same money back out, the Nasdaq 100’s forward-looking price-earnings ratio has shrunk from 27 to about 22 in three months.
The Nasdaq 100 lost 2.5% on Wednesday — its worst day this year — as Google-parent Alphabet’s disappointing cloud results outweighed Microsoft Corp.’s strong sales. The tech-heavy index notched its fourth drop of more than 1% in the last nine trading days and is currently down more than 9% from its July peak.
It didn’t take much to send Google into a tailspin. Third-quarter revenue beat forecasts thanks partly to advertising sales that Bloomberg Intelligence labeled robust, reflecting gains in search and YouTube. And yet investors still cut its market value to the tune of almost $180 billion, unloading shares that before the plunge fetched more than 21 times earnings and 6 times projected sales.
“Bears are looking for any year-to-date outperformer with a slight earnings problem as a target for selling,” said Mike Bailey, director of research at FBB Capital Partners. “Google fit the bill for this approach. A B+ result in Cloud was enough to send buyers running for the hills.”
To be sure, a selloff premised on valuations rather than business challenges, like falling sales or tightening credit, are in many regards the least traumatizing for investors. The $13.20 decline Wednesday in Alphabet rolled back only about a quarter of the rise to its highest point of 2023. The stock had rallied almost 60% this year through mid-October — only very recent buyers have lost money.
Alphabet’s selloff mimicked Tesla’s last Thursday. The electric vehicle-maker, which had rallied 97% this year through last Wednesday — the third-most in the S&P 500 — posted a 9.3% decline after its third-quarter results fell below consensus estimates for profit, sales and margins. The results prompted a string of price-target cuts.
The problem for bulls is that even with the shearing in valuations since July, price-earnings ratios in the Nasdaq 100 remain a long way from cheap. At just below 22, the index is still way above its floor valuation of around 19 in October of last year, and this with yields on 10-year Treasuries hovering around 5%.
“It has been a combination of weak earnings from some large cap Tech companies and the renewed bond selloff in the backend,” said Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs. “Ultimately equity risk premia are at multi-year lows and have compressed further since the summer bond sell-off started – this leaves little buffer for both further rate increases and earnings disappointments.”
–With assistance from Matt Turner.
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