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Tech Sector Seeks Q2 Reboot, But Challenges Keep Coming

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July 5, 2016
Technology sector market earnings and future potential.

After a tough first quarter, things don’t necessarily get easier for the technology sector as Q2 earnings season approaches. The shattering blow of Brexit, which hit technology stocks hard at the end of the quarter, adds additional question marks.

On the whole, it’s a wobbly time for many big technology companies, and Q2 earnings sector-wide are expected to fall more than 5% after a 4% earnings decline in Q1, according to projections released by S&P Global Market Intelligence in late June. That’s worse than the predicted total S&P 500 Q2 earnings projection of negative 4.9%.

Some of the sector’s biggest companies seem to be struggling with changes that arguably affect the very foundations of their business. And a look at the combined performance of six of the largest technology firms, including Microsoft (MSFT), IBM (IBM), Yahoo (YHOO), Netflix (NFLX), Intel (INTC), and Apple (AAPL), shows that these tech stocks have done worse than the overall market since the start of 2016, down more than 7% as of late June.

Tech stocks

FIGURE 1: BIG TECHNOLOGY STOCKS UNDERPERFORM SPX.

This chart, plotted on the TD Ameritrade thinkorswim platform, illustrates the combined performance year to date through late June of six of the most closely watched technology firms representing different segments of the industry vs. the green line representing the S&P 500 Index (SPX). While the SPX was down just a tad in 2016 even after Brexit, these six tech stocks are down more than 7%. Image Source: The TD Ameritrade thinkorswim platformFor illustrative purposes only. Past performance does not guarantee future results.

And as if things weren’t tough enough already, the June 23 Brexit vote by Britain to leave the European Union (E.U.) hit the tech sector hard, with investors concerned about the possibility of a Brexit-related recession in Europe that could hurt product demand from the huge E.U. market.

What's Ailing Big Technology?

Each of the large companies illustrated by the chart faces some key challenges, and many are embarking on different strategies to find their way forward. It’s unclear to analysts if the companies’ responses will work.

Take MSFT. The company made big news in June when it announced plans to buy LinkedIn (LNKD) for $26 billion. Microsoft believes LNKD makes good sense for its portfolio and may have synergies with its Microsoft 365 Office software. But the deal also points up MSFT’s need to branch out after Q1 earnings came in below the Street’s estimates amid falling Windows revenue and slowing Cloud growth. Will Q2 earnings show improvements in either of these areas, and what might MSFT’s executives say about the LNKD deal beyond what they discussed when it was first announced?

Then there’s NFLX, the S&P 500 Index’s best-performing stock in 2015 but down nearly 25% year to date as of late June. Has the company saturated the U.S. market, and will its huge international investments eventually pay off? The company’s Q1 earnings beat expectations, but international growth disappointed, with 6.74 million international subscribers added during Q1. Netflix said it would add 2 million international subscribers in Q2, but failing to meet that level could cause further disappointment among investors.

All Eyes on iPhone Sales When AAPL Reports

Apple’s Q1 performance came as something of a shock, marking the company’s first quarterly decline in 13 years.

The main headline was a drop in iPhone sales for the first time ever. AAPL has been hurt in part by a strong U.S. dollar, and also by falling iPad sales. The iPhone represents 65% of AAPL’s sales, so any continued fall-off could be a sign of more struggles. It could also be interesting to hear what AAPL executives have to say on their conference call about China’s recent injunction (which AAPL is challenging) on sales of the iPhone 6 and iPhone 6 Plus, based on a patent dispute. China is a key growth market for AAPL. On the plus side, the dollar was weaker for much of Q2, which may provide some lift for the company.

Amid the company’s woes, the once high-flying AAPL stock is now a laggard, down more than 12% year to date as of late June.

Shares of IBM, like those of AAPL, have come under pressure in the last year, but for different reasons. The company’s year-over-year revenue has declined for 16 consecutive quarters, and IBM faces the challenge of shifting toward cloud computing as it competes with Amazon (AMZN) to be the world’s largest cloud infrastructure provider. The Q2 earnings call could provide an update on IBM’s progress in that regard, and a chance to see if the weaker dollar conditions through much of Q2 may have helped sales somewhat.

Intel shares were down about 10% as of late June, but the company recently got a lift when an analyst reported that personal computer notebook shipments in May showed better than expected seasonal trends. Intel derives 55% of its revenue from the PC end market, but it seems to remain burdened by high inventory levels and its long focus on servers, desktops and laptops in an age that’s become more mobile.

Some Positive Signs on Horizon

While tech companies continue to face major challenges, Q2 may represent the beginning of better times, says Jim Kelleher, Director of Research and Senior Analyst at Argus Research. One big factor is that the dollar strength that’s weighed on so many company earnings is now being “lapped,” which means comparisons with a year ago are becoming easier. And while transition to the cloud has hurt the PC and hardware spaces, semiconductors and software have performed well.

And even if earnings on the whole aren’t too rosy, there’s guidance to consider.

“Tech companies under-guide and over-deliver, it’s the way they are,” Kelleher says. “The fact that they’ll over-deliver on Q2 means probably a break-even to low single-digit decline in earnings. And guidance could be positive, even if it’s cautious, as we start to ramp to the holiday season.”

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