A sudden spike in Treasury yields causes investors to flee stocks with the highest valuations because their distant earnings gains will be less valuable as rates rise.
Information Technology, one of the favourite sectors of global investors, is finding itself at a crossroad. While the Mega Cap technology shares have been at the forefront of the global equity rally all through the pandemic, the high valuations amidst the rising US yield and regulatory scrutiny may pose some concerns for the industry.
Share prices of Apple, Amazon, Facebook, Google and Netflix are up by 7.5 per cent, 0.81 per cent, 25 per cent, 55 per cent, and 13 per cent, Year-to-Date (YTD), respectively. The Nasdaq 100 index, the mirror of tech-heavy stocks, is up by almost 14 per cent YTD. Still, the rally in these stocks as seen in 2020 seems to have taken a back seat.
The matter of concern is the rising US yield for the future of these tech stocks. The US 10-year Treasury yield rose above 1.5%, for the first time since June and any upward pressure may keep the tech rally at bay.
But, how do rising yields impact the tech sector or for that matter any industry? A sudden spike in Treasury yields causes investors to flee stocks with the highest valuations because their distant earnings gains will be less valuable as rates rise. The 10-year Treasury yield is used to discount the value of future cash flows. The higher the yields go, the less those profits are worth now.
The graph below shows how the Nasdaq 100 has moved YTD as against the movement in the US 10-year Treasury yield.
However, things may not be as straightforward as it looks. The strength and the quality of the corporate balance sheet and future growth potential may overshadow the impact of rising yield to some extent. The strong balance sheets, powerful profit engines and steady business models of leading tech companies have kept them going through periods of tumult and transformed them into a quasi-safety trade.
Still, the sector rotation in one’s portfolio may not be ruled out. In Wall Street last week, Value stocks outperformed growth stocks and most sectors were higher with energy the biggest gainer, and the only sector higher for the week. Communication services, financials and materials were among the outperformers. Consumer sectors and healthcare underperformed, while utilities trailed.
According to FactSet, some pockets of skepticism surrounding the resilience of longstanding buy-the-dip mantra was seen in the market last week. But while bears have plenty of ammunition (not limited to supply chain worries, corporate warnings, lack of clarity on fiscal support, and the coming Fed taper), still some optimism about coming Q3 earnings season, a long runway until rates liftoff, improving Covid backdrop, better October/Q4 seasonality, and stabilizing economic indicators (with today’s improvement in September ISM manufacturing and UMich consumer sentiment indicators).
The top US tech stocks are expected to post higher earnings in the coming quarter. For a long term investor in US stocks, most of these top stocks such as Apple, Amazon, Facebook and others are trading at lower levels and could be added to one’s portfolio. growth and earnings outlook may well be the force that attracts global investors to these mega-tech stocks even in a rising interest rate scenario. Any corrections or dip in the prices may be used as an opportunity to accumulate the growth stocks with a long term view.