Why is Microsoft underperforming the Nasdaq and S&P 500?

Microsoft stock is lagging the wider market so far this year. While its Q2 cloud earnings were positive, a slowdown for the segment is now on the horizon, according to its recent earnings call, with the wider tech theme also looking shaky.

- Cloud sector slated to slow down in Q3, wiping post-earnings gains off share price.

- Job cuts of 10,000 on cards for Microsoft.

- The iShares Global Tech ETF offers exposure to Microsoft stock and has outperformed the tech-heavy Nasdaq 100 so far this year.

The share price of software giant Microsoft [MSFT] has been underperforming the Nasdaq and S&P 500 in 2023, with a projected slowdown for its cloud sector in the third quarter being a key factor.

On 24 January, Microsoft delivered its second quarter (Q2) 2023 results, announcing better-than-forecast earnings, with cloud sector growth especially strong. However, overall revenues of $52.7bn, while up 2%, missed forecasts by Zacks of $53bn.

Microsoft stock spiked 4% in after-hours trading on the day it posted earnings, but slumped the following day, falling as low as $230.90, before closing down 0.6% at $240.61. It has since recovered to close at $248.16 on 27 January, but it’s a long way from its level of above $300 this time last year.

While Microsoft’s share price has crept up 3.5% in 2023 so far, this is trailing the S&P 500’s growth of 6%, while in the same period the tech-heavy Nasdaq 100 rose 10%.

Azure cloud growth slowdown

The fall in Microsoft’s stock comes directly on the heels of a warning that its Azure cloud business will slow across 2023 and 2024.

Revenue for Microsoft’s cloud sector hit $21.51bn, an 18% leap year-over-year, making it a highlight in the company’s Q2 earning report.

However, following the results, Microsoft announced that Azure sales would drop by 4 or 5 points from the end of the last fiscal quarter ended December 2022.

Microsoft’s More Personal Computing segment suffered in Q2, with PC, Windows and Xbox sales all dwindling. Revenues fell 19% to $14.2bn, and this is pegged to fall even further to between $11.9bn and $12.3bn for Q3.

Microsoft now expects a total $50.5-51.5bn of revenues for Q3, a reduction of up to 4.2%.

In Q3 its overall revenue growth slowed to just 2%: its lowest growth rate since 2016.

A challenge for Microsoft in the current microeconomic climate is that corporate customers are curbing spending; as Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, recently said, companies and consumers “are clearly belt-tightening”.

Microsoft’s share price crashed 28% during 2022 as the tech theme suffered headwinds including spiralling inflation, soaring interest rates and a general lack of consumer confidence.

As fears of recession mount – a recent Wall Street Journal poll of economists puts the chances at 61% – the question is whether Microsoft’s share price can recover.

Tech staff cuts widespread

Investors will be closely watching the post-earnings share price performance of Microsoft, one of the first big tech firms to report this year. The company is often regarded as a bellwether for the industry.

Wall Street analysts are expecting a difficult 2023 for the tech sector, and for it to drag on the S&P 500’s performance in the coming period.

The theme is still reeling from a tough 2022, making a stark contrast to its bullish run early in the Covid-19 pandemic. Job cuts are now impending at many tech firms. On 18 January, Microsoft announced it is laying off 10,000 staff, with analyst Wedbush analyst Dan Ives calling it a “rip-the-Band-Aid-off moment”.

Fellow leading tech names Amazon [AMZN] and Meta [META] are cutting 18,000 and 11,000 jobs, respectively.

While Microsoft’s job cuts will incur a $1.2bn charge, they should save the company money overall. Ives said he regarded it as a “proactive, smart move” that would be replicated across the space, and which could preserve earnings margins.

Funds in focus: Technology Select Sector SPDR Fund

The Technology Select Sector SPDR Fund [XLK] offers exposure to MSFT stock: it is currently the second-largest holding in the fund, with a 20.80% weighting as of 26 January, behind Apple [AAPL] in first place at 22.28% of assets under management (AUM). The fund has gained 9.9% year-to-date, but is down 12.6% over the past 12 months.

The iShares Global Tech ETF [IXN] also offers investors exposure to Microsoft shares. As of 27 January, Microsoft is the second-largest holding at 16.46% of AUM, again trailing Apple stock at 19.41% of AUM. IXN is up by 11.3% year-to-date, but has tumbled 13.2% over the past 12 months.

MSFT stock is again the second-biggest holding in the Vanguard Information Technology ETF [VGT]. Microsoft has a 18.12% weighting in the portfolio as of 31 December. Apple is again the top holding, at 20.42% of AUM. In 2022, the fund slipped in value by 13.4%, but it is up 10.2% year-to-date.