Why Apple path to $1 trillion value matters for whole market

Animal spirits have returned to rule over U.S. stock markets, and they're into high-tech.

US techs back at Club 1999

We see them reflected in the Nasdaq Composite passing its 6,000 milestone last week with the S&P 500 Information Technology index having a similar moment.

S&P’s IT sector is finally challenging levels last seen during the turn-of-the-century dot com boom. Apple, Amazon, Google, Facebook and other giants are lifting the overall market.

Information Technology is the biggest gaining sector so far this year, with a rise of more than 16%, having recently surpassed the S&P’s bank index as the market leader.

DAILY CHART: S&P 500 BANK INDEX VS. INFORMATION TECHNOLOGY INDEX

Source: Bloomberg and City Index

In fact the biggest techs aren’t even the best outperformers. Video game group Activision Blizzard is king of the wall with a 44% rise so far this year. Maker of semiconductor manufacturing hardware, Lam Research is next with a 37% rise, followed by radio chip maker Skyworks Solutions, +34%, Facebook, +30.6%, and Amazon, Alphabet and Netflix 17%-23% higher.

In terms of market weighting though, the FANG stocks are indeed doing the heavy lifting. And with the major technology groups’ earnings season in full swing the largest internet and cloud focused groups are on a run of strong quarterly numbers. At the same time, Google-owner Alphabet is locked in a race against Amazon, to be the first $1000 ‘new technology’ stock, though that is another milestone of largely artificial importance. Both remain firmly in the shadow of the most valuable company, Apple.

More importantly, Information Technology looks on track to have another pop at its record closing high of 988.49 of 27th March 2000, with a previous monthly closing high of 916.71 that same month. Information Technology was just 6.15% away from its all-time peak at the time of writing. It is, however, difficult to weight the probabilities of whether techs will scale the remaining heights to their record, or fail around current levels before a protracted downturn

Apple’s low PE is still too big to scale

As the most highly valued company on the global stock market, Apple’s valuation is in sharp focus, but there lies a paradox. In terms of trailing price-to-earnings (PE) ratio, a rule of thumb relative value gauge for many investors, the group appears to lag the rating of the broader market, with S&P 500’s PE at 21.34 times last year’s earnings against Apple’s at 16 times. This mismatch, of course, reflects the difficulty of the group’s already enormous income and market capitalisation to grow further anytime soon. That of course assumes that PE is still a valid way of assessing the world’s biggest stock, which now has a market capitalisation of $774bn.

QUARTERLY CHART: APPLE INC. MARKET CAPITALISATION (U.S. DOLLARS)

Source: Bloomberg and City Index

We expect the proximity of that market cap to its next most obvious milestone of $1 trillion in itself to propel the stock higher by momentum alone. That gives the target both a seminal value for the Apple shares and for the market too. Like Dow Jones 20,000 handle, Nasdaq’s 6,000 and the watch for Google and Amazon to hit $1,000, a $1 trillion Apple has little financial significance in itself. However few investors—from the most sophisticated hedge funds, to we individual traders—will be able to ignore it, which is where momentum comes in.

And with technology shares apparently on a tear, focus on Apple’s market cap milestone could make the difference between the sector properly hitting its historic peak, and falling short.

iPhone sales on hold

After a stellar year to date though, Apple shares could now be set for a pause, looking at the latest set of  the company's always closely watched quarterly earnings released overnight. Investors are likely to reassess the 27% sprint by Apple shares so far this year when U.S. stock trading gets underway on Wednesday. That’s because expectations that the world’s most valuable company was about to put a tough year behind it with a resumption of iPhone sales growth have turned out to be premature.

Handset sales were well under Wall St. forecasts of around 52.7 million in Apple’s second quarter, slipping to 50.76 million from 51.19 million in the same quarter of 2016. iPhone sales, which still account for about 60% of Apple revenue, had apparently stabilised at the start of the year.

In reaction, Apple shares fell about 2% in ‘after hours' trading on Tuesday night having closed mildly higher at $147.51, the latest of several recent record highs.

A handful of factors around iPhone sales could soften the let-down for investors.

Firstly, Apple actually reports ‘sell-in’—AKA wholesale iPhone sales figures, as opposed to retail sales. This practice might be masking a better tally than readily apparent. Obviously, the moderate iPhone sales shortfall relative to expectations could be resolved by up-to-the-minute data too.

Additionally, the group says it sold down inventory of about 1.2 million handsets through its own retail channels, including Apple Stores during the quarter, bringing total handsets retailed closer to analysts' forecasts.

Even without these upsides—and the fact that handset revenues actually rose 1.2% —investors might still conclude there are positive sides to a slightly soft headline iPhone result given that it suggests customers are beginning to anticipate Apple’s long-trailed 10^th anniversary handset update that should hit in the autumn.

Facebook video in focus

Next up for investors in Big U.S. tech will be earnings scheduled for Wednesday evening from social media leader Facebook, whose shares have also been rocketing, also hitting a record high on Tuesday. Wall St. has been hanging its hopes just as much on the $442bn Menlo Park, California, internet behemoth to keep the tech sector’s run going. With Apple disappointing (slightly) overnight, a greater onus falls on FB. Again, just like Apple, Facebook is also eyed by investors to potentially benefit from plans by President Donald Trump for tax cuts and reduced tax restrictions on profits made abroad.

Facebook and Alphabet-owned Google, received 77% of gross spending on digital advertising in 2016, compared to 72% the year before, according to an analysis of industry data by Pivotal Research. More broadly, technology company earnings are expected to have grown 17.7% in the latest three months, the strongest quarterly expansion since 2014, according to Thomson Reuters I/B/E/S.

Facebook is forecast to report, when it releases earnings after the U.S. market’s close on Wednesday, another leap in earnings per share (excluding certain expenses) to $1.12, from $0.77 in its first quarter of last year, and a 46% surge in revenues to $7.83bn from $5.38bn.

The group’s increasingly multifarious advertising revenue channels will require additional focus on a number of fronts. A particular watch for the quarter however is the group’s increasing load of video ads, which could offset what FB warned last year might be a “meaningful” drop in advertising growth, expected in the current year.

Another let-down in Big Tech earnings however would probably weigh on the whole sector, laying an additional hurdle between its shares and further gains. Still it's worth remembering that Facebook’s recent run of quarterly results has repeatedly paced high expectations, even after the group attempted to manage market views lower. If Wednesday evening’s earnings report follows a similar pattern, fresh FB record highs are likely, and other technology focused shares will get a sizeable nudge too.