By David Randall

NEW YORK (Reuters) – A blistering rally in megacap growth and technology shares has buoyed markets this year, and earnings reports in coming weeks could help investors determine if those gains are justified.

U.S. technology stocks are currently the “most crowded” trade in the market, fund managers surveyed by BofA Global Research said, as investors pile into megacaps thinking the Federal Reserve will soon stop tightening monetary policy and that the sector will remain resilient as growth slows.

Rallies in stocks such as Apple Inc, Microsoft Corp and Tesla Inc have helped sustain broader indexes in the face of recession worries and last month’s banking crisis sparked by the collapse of Silicon Valley Bank and Signature Bank.

Apple and Microsoft, up 27% and 19% this year, respectively, together accounted for nearly half of the S&P 500’s total advance through March, according to S&P Dow Jones Indices. The index is up around 7.5% year-to-date.

Whether that rally continues could depend on companies beating already-lowered first-quarter estimates. Technology earnings are seen falling 14.4%. Communication services companies, including Meta Platforms Inc and Alphabet Inc, are expected to post declines of 12%, according to Refinitiv data.

After steep declines in 2022, “this is a group that was an underweight for a number of people and now you’re seeing some of the momentum take off,” said Jason Draho, head of asset allocation Americas at UBS. Earnings will show “whether this is really a safe haven if you are worried about recession.”

Alphabet and Microsoft are expected to report their results on April 25, followed by Apple on May 4. Amazon, part of the consumer discretionary sector, is expected to announce results on April 27. Tesla shares fell nearly 10% after missing earnings estimates on April 19.

GRAPHIC: US tech stocks regain some lost ground https://www.reuters.com/graphics/GLOBAL-MARKETS/THEMES/znvnbjybgvl/chart.png

Companies will likely use earnings reports over the next several weeks to announce further plans for layoffs, which could bolster margins ahead of a recession and make their shares more attractive, said Robert Stimpson, co-chief investment officer and portfolio manager for Oak Associates Funds.

Alphabet in January announced 12,000 job cuts, followed by Amazon in March with 9,000 cuts, and others that bring the total to 27,000 layoffs over recent months.

“Tech corrected very hard last year and it’s already discounted for some sort of recession, given that it has accepted that it has to cut headcount and retrench a little bit,” said Stimpson. “It’s an industry that is accepting its medicine.”

Stimpson is overweight technology and cutting back on his energy exposure in anticipation of a recession.

However, signs of improving profitability could power “another leg up” in the rally, said Tom Plumb, portfolio manager of the Plumb Funds, who has large positions in Nvidia Corp and Apple. Nvidia shares are up more than 90% this year. “We paid the penalty for holding on to a number of these stocks last year,” Plumb said. “In today’s market growth is something that people think will be a challenge and if you can identify growth you’ll be rewarded.” Still, gains could fizzle if the Fed does not cut interest rates this year, as widely expected. While the central bank has projected borrowing costs will stay around current levels until year end, investors are pricing rate cuts after the summer.

Elevated rates would likely weigh heavily on technology valuations, which have soared since the year began, said Max Wasserman, senior portfolio manager at Miramar Capital. Growth stocks are especially vulnerable to high borrowing costs, which threaten to erode the value of their longer-term cash flows.

Apple is trading at a forward price-to-earnings ratio of 26.5, while Microsoft’s ratio is 27.4, compared to 18 for the S&P 500. “You’re seeing extremely high multiples in a rising interest rates environment because the market is betting the Fed will reverse its policies,” he said. “We think it’s a faulty assumption and the risk-reward is not in your favor.”

(Reporting by David Randall; Editing by Ira Iosebashvili and Richard Chang)

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