Sky-High Tech Valuations Could Sink U.S. Stock Market Post-Earnings

• Technology stocks have surged to record highs this month, but the rally could fizzle due to meager earnings.
• Technology shares have the highest multiples since the dot-com bubble, a sign of significant overvaluation.
• Microsoft will release second-quarter results Wednesday after the bell. Facebook, Amazon, Apple, and Alphabet will report later this month.

Overvalued technology stocks are about to have their day of reckoning as quarterly earnings reveal the extent of the pandemic-induced damage. Although earnings have mostly been better than expected so far, Netflix’s (NASDAQ:NFLX) recent report showcases what could happen if actual results fail to meet forecasts.

Are Mega-Caps In Trouble?

Quarterly earnings could be the catalyst that sinks mega-cap technology stocks–a move that would send the broader market lower–according to Jonathan Krinsky of Bay Crest Partners.

In an interview with CNBC, Krinsky said :

A lot of these mega-cap names are very stretched relative to their long-term moving averages as they come into earnings.

Meager earnings could trigger a “sell-the-news” event, according to Krinsky.

That’s what happened to Netflix last week after the video streaming giant reported weaker than expected earnings. The stock plunged more than 6% on Friday.

Technology stocks have been the biggest movers and shakers in the S&P 500 Index. Their performance has masked weakness in other sectors of the stock market amid the pandemic. Without technology stocks, the S&P 500 would be worth less than 2,950 .

Overvaluation Risks

Technology stocks are due for a pullback because they are significantly overvalued relative to earnings. Growth stocks in general–and software companies in particular–carry their highest multiples in two decades, according to Goldman Sachs .

Mega-cap stocks like Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) are also trading well above their 200-day moving averages.

Each of these companies will report earnings this month, with Microsoft set to report after the bell on Wednesday.

So far, Q2 earnings season has been better than expected. As of July 17, 9% of the companies in the S&P 500 had reported results ; nearly three-quarters (73%) reported positive earnings surprises.

Beating earnings expectations isn’t hard to do, given how low the bar is set on Wall Street. If technology shares aren’t able to meet their suppressed guidance for Q2, then a broad correction could ensue.

Stocks Overcome U.S.-China Tensions

After trading lower in the pre-market session due to geopolitical tensions, U.S. stocks opened higher on Wednesday. The Dow Jones Industrial Average rose 37 points or 0.1%. The S&P 500 Index climbed 0.2% and the Nasdaq traded 0.4% higher.

The tech-heavy Nasdaq is up over 19% this year and has set multiple record highs amid the pandemic.