Speculator Comeuppance Is Fast and Harsh in Tech’s Waterloo Week
(Bloomberg) -- The biggest week of the earnings season ended in carnage for America’s giant technology companies, dealing especially painful blows to traders who flocked to speculative corners of the market to wager on gains.
The S&P 500 slumped 5.6% in its worst week since March, led by shares of megacap tech companies that reported solid quarterly results just days earlier. Losses in the tech-heavy Nasdaq 100 exceeded 3% at one point on Friday. And in the options market -- where open interest had exploded in single-stock calls ahead of earnings -- bullish contracts expired next to worthless as the tech bloodbath dragged them out of the money.
As in any widespread stock-selloff, examples of options pain are easy to locate. A call with a $205 strike price on Microsoft Corp. expiring Friday plunged nearly 96% as shares sank almost 6.5% over the week to end near $202. A bullish wager for Amazon.com Inc. to reach $3,100 by Friday effectively lost all its value as the e-commerce giant dropped over 5% to $3,036. A call contract on Facebook Inc. with a strike price of $265 met the same fate as the stock closed more than 7.5% lower at $263.11.
While the Nasdaq 100 remains more than 25% higher this year, the buy-at-all-costs spirit that drove the rally is starting to fizzle as investors question sky-high valuations against a backdrop of climbing coronavirus cases. With fears of further economic pain growing, pressure is rising on tech companies to deliver the profit growth needed to justify their lofty price-tags. With U.S. presidential election on Nov. 3 and concerns that a Democratic sweep could bring higher taxes and increased regulatory scrutiny, this week’s earnings showing wasn’t enough to assuage the market’s nerves.
“The valuations in a lot of these large tech names are fairly rich, and the market was expecting a larger beat than what was presented,” said Jeff Schulze, investment strategist at ClearBridge Investments. “With a fear of a slowing U.S. economy, investors are starting to worry they won’t be able to hit what the expectations are, looking out to the horizon in 2021.”
The selloff in Nasdaq megacaps is all the more painful because it came alongside earnings that were by most definitions stellar. Despite all five FAAMG companies reporting profits that blew past estimates, not one finished the week higher.
A comparison with last quarter’s earnings season may shed light on how sentiment has rapidly turned against ultra-expensive digital companies. Over that stretch, in July, the five largest companies reported almost identically impressive earnings -- all but one surpassing Wall Street forecasts -- and that week saw the group surge 6% on average.
Between the opposite earnings reactions was an advance that added $1.2 trillion in their combined share value over the two months through the market’s peak in early September. In other words, a valuation case can be made that any good news was pretty much priced in this time around. At the end of the third quarter, the Nasdaq 100 traded at 28 times forecast earnings, roughly 1 point above where it was three months ago.
The swift reversal was particularly bruising in the options market, where single-stock volume -- concentrated in megacap tech -- has been surging. Total call open interest in Microsoft, whose revenues handily beat estimates, rocketed to the highest level since 2014 this week. In Amazon, Facebook and Google’s parent Alphabet Inc., open interest on bullish contracts was all near recent highs.
“There were all sorts of options traders bulled up about the prospects for good earnings,” said Steve Sosnick, chief strategist at Interactive Brokers. “They’re out of luck. With rare exceptions, the bullish options bets failed to pay off.”
Another difference between now and July involves sentiment. Back then, everyone was piling into tech giants, some via risky wagers like call options, emboldened by the belief that their strong balance sheet and ability to facilitate stay-at-home demand would help insulate the group from the pandemic fallout. And they did fare better. Total profit in the third quarter rose 7%, compared with an expected 20% decline for the rest of the S&P 500, data compiled by Bloomberg Intelligence show.
But the-only-game-in-town mentality has slowly dissipated. More investors started to embrace laggards such as small-cap and industrial stocks in anticipation of an economic recovery. Indeed, tech megacaps’ huge growth edge is poised to disappear soon. Profits from the big five are forecast to increase 23% in 2021, pretty much in line with the market, according to analysts estimates compiled by Bloomberg Intelligence.
“They certainly had robust earnings, but what markets are concerned about is how much activity has been pulled forward,” said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management. “What are the prospects for overall economic growth without that fiscal stimulus? I think it’s challenging for the economy overall, but tech in particular.”
©2020 Bloomberg L.P.