What Microsoft’s Downbeat Outlook Means for Tech ETFs

The company suggested tech spending would continue to decelerate next quarter.

An earnings beat from Microsoft Corp. was overshadowed by disappointing guidance for the tech giant’s cloud unit, sinking shares of the Redmond, Washington-based firm as well as other cloud-related stocks and exchange-traded funds. 

After the bell on Tuesday, Microsoft reported its fiscal 2Q earnings came in at $2.32 per share, edging ahead of the $2.30 analysts were expecting based on Bloomberg consensus estimates.  

Microsoft reported revenues of $52.76 billion, slightly below the $52.93 billion analysts were anticipating.  

On a year-over-year basis, revenues were up by only 2%—the slowest pace of growth since 2016. Adjusting for currency fluctuations, Microsoft’s revenue growth was 7%. 

Low Bar 

As tepid as Microsoft’s growth was in the second quarter, it seemed to have cleared the low bar that the company set in its first-quarter earnings conference call. The stock’s initial reaction—up as much as 5% in the after-hours market—reflected investors’ relief that the 2Q numbers weren’t worse. 

The 38% constant currency revenue growth in Microsoft’s Azure business unit was also seen as relatively robust, helping to offset the 16% plunge in sales at the company’s personal computing division. 

The cloud unit is the linchpin of Microsoft’s ambitions to capture a significant portion of the growing value of digital technologies. Everything from enterprise software-as-a-service to AI models to streaming services runs on cloud computing platforms like Azure.  

That’s why when Microsoft CFO Amy Hood told analysts on the 2Q earnings conference call that Azure growth would decelerate to around 30%, the stock gave up all of its gains and more. 

The stock fell as much as 4.6% on Wednesday morning, though as of this writing, the stock had recovered nearly all of its losses. 

ETF Impact  

As the second-most valuable company in the U.S. behind Apple Inc., movements in Microsoft have an outsized impact on many ETFs. 

The stock’s weighting in the SPDR S&P 500 ETF Trust (SPY) is more than 5%, and nearly 12% in the Invesco QQQ Trust (QQQ). 

Aside from the direct impact of Microsoft’s stock performance on these ETFs, the company’s comments carry a lot of weight for the tech sector in general. 

When Microsoft noted that customers are exercising caution and the firm’s results weakened through December, that was interpreted as a bad omen for other tech companies—particularly those selling software and cloud services. 

Everything from Amazon.com Inc. to Salesforce Inc. to Datadog dropped on Wednesday morning, pulling down ETFs like the WisdomTree Cloud Computing ETF (WCLD) and the Global X Cloud Computing ETF (CLOU). 

Bottoming Out? 

Yet as downbeat as Microsoft’s near-term outlook was, the impact on the company’s stock and the broader tech sector was relatively limited.  

A few months ago, the type of guidance Microsoft provided would have led to much heftier losses for stocks in the industry, suggesting a lot of bad news has been priced into these names. 

Stocks are forward-looking and tend to move ahead of the fundamentals. So if the next quarter or two mark the bottom for the growth in tech spending, it makes sense that tech stocks and ETFs would rise ahead of that. 

But that assumes that the bottom is around the corner.  

The deceleration in revenue growth for many tech companies over the past few quarters is largely a function of tech spending reverting to the mean after two years of gangbuster growth in the aftermath of COVID-19.  

It’s the same reason all of these companies are laying off workers and their stocks have collapsed. The tech sector essentially went through its own boom/bust cycle that’s been separate from the broader economy. 

The broader economy is still important, and if Fed rate hikes push it into a recession, spending on tech products and services could dip further, taking tech stocks and ETFs down with it. 

Yet if a recession can be avoided, maybe we’ve already seen the worst for this group. 

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2