If you love this tech rally, thank the Fed

Nasdaq profits up, but they aren’t being driven by earnings

This month’s big rally in large-cap technology stocks is one value investors worried about overpaying for profit growth may want to sit out.

That’s because it’s not supported with higher earnings expectations for the sector this year.

Indeed, profit declines at tech firms for the second quarter, the third quarter and all of 2016 are expected to be worse than those for the S&P 500 companies as a whole. That dynamic has driven the price-to-earnings ratio of the Nasdaq Composite Index well above historical norms. Its currently at 16.4 for trailing 12 months’ earnings vs. a fiveyear average of 13.6, says Zacks Investment Research.

Whether you look back at earnings over the 12 months or look ahead to the end of this year, the story is the same.

Yet even as earnings in the tech sector are expected to fall 3.5% for all of 2016, shares of Microsoft, Alphabet and Facebook soar to near-term highs.

If it’s not higher profits driving the buying, what is it? That question can be answered with another: Why buy U.S. government bonds paying historically low interest rates when you can buy well-known tech names paying even higher dividends? You don’t.

“The Fed is playing a huge part in this rally,” says Sheraz Mian, head of research at Zacks Investment Research.

Fears of a Brexit-driven global economic slowdown, which would put further pressure on earnings, have nevertheless (paradoxically) given investors a reason to buy stocks, Mian says.

Central bankers in both the United Kingdom and Europe have signaled they’re ready to lower rates, to counter any Brexit effects. With Federal Reserve Chair Janet Yellen signaling that the U.S. central bank has put any rate hikes on hold, long-term bond yields in the U.S. have dropped to historic lows. “This is not earnings-driven,” Mian says.

The second quarter will be the sixth consecutive period of yearover-year profit declines for the sector. Yet the Nasdaq is sitting within 5% of its all-time high of 5,231, which it reached last July.

The best earnings news related to the second half of 2016 is that estimates for the period haven’t come down as much as those for the first half did during reporting season, Mian says.