Wall Street Week Ahead: Tech haves and have-nots face third-quarter tests

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By Lewis Krauskopf

NEW YORK (Reuters) – Technology companies, which make up the largest swath of the U.S. stock market, are expected to post a nearly 8% drop in third-quarter profits as reports roll in next week from many of the sector’s biggest corporations.

But below the surface, the estimates reveal a wide range among the companies that comprise the S&P 500 information technology sector (), which includes Apple Inc (O:), Microsoft Corp (O:) as well as communications equipment, hardware and IT services companies.

The overall sector’s earnings performance is being dragged down by semiconductors, which are expected to post a nearly 27% plunge in quarterly profits, according to IBES data from Refinitiv, as analysts point to impact from the U.S.-China tariff conflict and generally weak demand.

Growing business IT spending continues to support other pockets of tech, according to investors. Software firms are poised for a nearly 11% gain in profits from a year ago, according to the IBES data from Refinitiv.

“You may have two dynamics going on in tech in the opposite direction,” said John Augustine, chief investment officer at Huntington National Bank in Columbus, Ohio. “Can software live up to the numbers and will semis beat the numbers?”

Among software companies, Microsoft, the largest U.S. company by market value, reports results on Wednesday, while earnings are also due next week from semiconductor stalwarts Intel Corp (O:) and Texas Instruments Inc (O:).

Other tech earnings next week include payment processors PayPal Holdings Inc (O:) and Visa Inc (N:), with iPhone maker Apple, whose results ripple through its supply chain, expected to post a 2.7% drop in earnings when it reports the following week.

One of the early reporters, International Business Machines Corp (N:), kicked off the season on a sour note on Wednesday, with quarterly revenue that missed estimates.

(GRAPHIC – Tech’s third-quarter outlook: https://fingfx.thomsonreuters.com/gfx/editorcharts/USA-STOCKS-WEEKAHEAD/0H001QXE0902/eikon.png)

Even with the disparate forecasts for the third-quarter company results, tech stocks are outshining the market broadly in 2019.

The S&P 500 tech sector, which comprises over one-fifth of the benchmark index, has climbed more than 30% in 2019, compared to a 19% rise for the S&P 500 ().

Federal Reserve easing of interest rates has helped the performance, which comes despite uncertainty about the health of the global economy and about U.S.-China trade tensions.

Tech is “the primary growth engine of the economy,” said David Joy, chief market strategist at Ameriprise Financial (NYSE:) in Boston.

“China is an issue for them, but at the same time they continue to grow and they continue to innovate,” Joy said. “You have to have exposure in technology. We just think as you look around at the market landscape, it’s one of the better places to be right now.”

The tech sector’s strength is broad-based, including gains so far this year of about 30% or more from the four biggest industry groups by market value within the tech sector: software , IT services , hardware, storage & peripherals and semiconductors .

“The IT budget continues to garner more dollars from the general budget of Corporate America,” said Michael Seidenberg, portfolio manager for the global technology team at Allianz (DE:) Global Investors. “There will be winners and losers within the sector, but I think generally speaking that is a trend that has persisted.”

Of U.S. corporations, semiconductor makers are seen as among the most affected by the U.S.-China trade tensions, which have triggered big swings in their shares.

But the stocks still have prospered: the Philadelphia SE Semiconductor Index () has climbed nearly 40% this year to all-time highs, while three chip stocks – KLA Corp (O:), Lam Research Corp (O:), Advanced Micro Devices Inc (O:) – are the tech sector’s biggest 2019 gainers.

Despite the steep decline in third-quarter profits projected for S&P 500 semiconductor companies, analysts are optimistic there will be improvement soon, with semiconductors expected to post an 11% rise in 2020 earnings, according to Refinitiv data.

“To me, there’s a huge disconnect between the performance of these names and the underlying fundamentals,” said Daniel Morgan, senior portfolio manager at Synovus Trust in Atlanta.

For software and other tech companies, the third quarter can be seasonally weak, said Kim Forrest, chief investment officer at Bokeh Capital Partners in Pittsburgh, who said she would be looking for executives to comment on whether business is being pushed back to future quarters.

But the strong employment market has supported tech stocks, Forrest said.

“This a phenomenon you see in the late stages of an expansion,” Forrest said. “Hiring is up and to support all the new people that you’ve hired, you to add to your technology.”