In normal times, such rapid increases in estimates would justify valuations that have been stretched to levels last seen in July. But these are not normal times — the Federal Reserve’s inflation battle has pushed Treasury yields to the highest in 16 years, amplifying recession angst. Investors punished big tech along with virtually every other sector in the market last month.

(Oct 2): The central argument for buying shares in highly valued Big Tech companies this year — unmatched prowess in generating earnings — is starting to look prescient.

The profit machines at the likes of Amazon.com Inc and Meta Platforms Inc are humming, with each seeing analyst projections for 2024 earnings per share rise by more than 10% in the past three months, according to estimates compiled by Bloomberg. Alphabet Inc’s estimates have risen 8%, while Nvidia Corp’s have soared 69%.

Investors now face the task of deciding whether the recent weakness that plunged tech shares into a correction will persist as the economy slows, or whether the pullback has made valuations, though still stretched, tempting given Big Tech’s earnings bulwark.

Anthony Zackery, associate portfolio manager at Zevenbergen Capital Investments LLC, is in the latter camp.

“These are some of the best businesses ever created based on their scale, their quality of management, their growth durability and their profitability,” he said, adding that they look attractive from a long-term perspective. “We believe that they can outgrow the broader economy.”

In normal times, such rapid increases in estimates would justify valuations that have been stretched to levels last seen in July. But these are not normal times — the Federal Reserve’s inflation battle has pushed Treasury yields to the highest in 16 years, amplifying recession angst. Investors punished big tech along with virtually every other sector in the market last month.

Take Nvidia, the stock that became the face of this year’s AI frenzy, with its shares more than tripling and its price-to-projected earnings ratio hitting a high of 63 in May. Even as analysts rushed to raise their estimates, the stock has plunged 11% from its August high and it’s now priced at 29 times profit estimates.

According to Goldman Sachs Group Inc analysts, the Nasdaq 100’s biggest monthly decline this year in September has left US tech stocks primed to turn a corner, given their historically cheap valuations at a time when earnings estimates are still rising.

Still, for others such as Nicholas Colas, co-founder of DataTrek Research, the mood shift on markets — where recession fears have trumped AI euphoria — poses more than a passing threat.

“Tech stocks have had an orderly selloff despite higher rates because the market thinks their earnings will continue to hold up,” he said. “The recent sharp ascent in rates could challenge that outcome, however.”

A longer-term higher interest rate environment means that fundamentals will be even more important for picking winners in the technology sector, according to Lara Castleton, US head of portfolio construction and strategy at Janus Henderson Investors. Margins, solid leadership, competitive advantages as well as a shored up balance sheet are more in focus than they were in the last decade, she said.

This is especially true for the megacap technology companies that have seen huge stock gains this year.

“If there’s any sort of hiccups in the economy when you’re priced close to your historical averages or even higher, there’s just a lot more downside risk,” Castleton said.

To be sure, Wall Street doesn’t unanimously see earnings jumping higher for all of the tech giants. Analysts have only slightly boosted next year earnings estimates for Apple Inc, up 0.2% in the last three months. And, the Street has trimmed its expectations for Microsoft Corp’s fiscal 2024 earnings by 0.2%.

Still, bulls think megacap tech stocks are worth the risk, given their potential upside and appealing valuations.

“For those who want to create wealth and build wealth over time, it will likely pay to own equities and big tech is still attractive relative to other pockets of the market,” Zackery said.