Cash and Cloud Are Keys to Big Tech Leading an S&P 500 Revival

(Bloomberg) -- Big Tech's ability to rescue the broader S&P 500 Index from its January rates-driven selloff rests on two factors: the cloud and cash.

Advertising has been a key component to the company's outsized performance, accounting for 82% of its revenue. Just 8% comes from its cloud business. But in the longer-term, the cloud could be the key to sustaining Alphabet's growth trend.

Cloud technology has been around for years, but demand is growing fast as companies increasingly shift to at least partial remote working in the post-pandemic era. These investments are likely to keep the momentum going in the cloud business, making it increasingly important to Alphabet and Big Tech more broadly.

“Only 44% of workloads are on the cloud today and poised to be 55% by the end of 2022 during this digital transformation,” Wedbush analysts Dan Ives and John Katsingris wrote in a note. “Important data points from Google and Amazon will be key around the cloud story with the Street laser focused on the overall demand story for 2022 and beyond.”

Big Tech is carrying a heavy load into this earnings season in light of the group's outsized weighting in the S&P 500. Tech bulls are looking to strong reports to rescue the stocks from recent rate-driven selloff that sent the Nasdaq Composite Index close to a 20% technical bear market from its Nov. 22 peak. And one problem may be the piles of cash on their books.

The massive bundles and low borrowing rates transformed Big Tech haven stocks with pricing power and a financial cushion. But in the face of an aggressive U.S. tightening cycle, those reserves have turned into a burden. The largest cash holders in the S&P 500 beyond the big Wall Street banks are Apple and Alphabet, which hold $202 billion and $142 billion, respectively.

Rising inflation and interest rates regime means cash will be worth less in the future. As a result, Big Tech stocks have effectively become rate plays.

The 40-day correlation between the tech-heavy Nasdaq 100 Index and the 10-year yield is positive, but in reality the two have been diverging over the longer term. On any given day, the two usually move in the same direction, suggesting tech's role as an inflation hedge given its pricing power. However, the sensitivity becomes more clear on a weekly basis as the bond market increases bets on more rate hikes for the year.

The latest strong earnings from Apple and Microsoft have encouraged investors. But the spotlight now falls on the Big Tech companies that are more sensitive to the underlying economy. Alphabet, for example, often serves as a leading consumer indicator, while Amazon provides a real-time snapshot of spending patterns. In light of the latest tech-led stock market correction, cash and the cloud could be key to determining how much support the S&P 500 has beneath it.