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Why tech stocks hate higher interest rates: Morning Brief

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Tuesday, January 31, 2023

Today's newsletter is by Julie Hyman, anchor and correspondent at Yahoo Finance. Follow Julie on Twitter @juleshyman. Read this and more market news on the go with the Yahoo Finance App.

It's a refrain we've heard at Yahoo Finance for months: tech stocks can't turn around until the Federal Reserve stops raising interest rates.

Or at least until investors believe the Fed will stop soon.

The Nasdaq has bounced this year, as investors look ahead to the central bank's "pivot" away from higher rates and towards a pause or cut. That anticipation is part of the reason why yields on the benchmark 10-year Treasury note have come down from a high of 4.24% in late October to around 3.5% now.

It's also part of the reason why tech stocks have rebounded.

So, why are rising interest rates so problematic for tech stocks in the first place?

Speaking in generalities, tech companies are, by and large, growth companies.

To fuel that growth, they rely in part on borrowing money, regardless of whether companies use this money to hire software engineers, produce must-see streaming shows, or make smartphones. When interest rates are low, it's cheaper to borrow more money for more initiatives and grow, grow, grow.

At the same time, investors who want high returns are incentivized to invest in growth stocks when rates are low.

"The logic is that tech stocks are the ultimate long-duration asset," said Interactive Brokers Chief Strategist Steve Sosnick. During the 2010s, tech stocks were certainly seen as a more attractive investment than parking money in low-risk, low-yielding government debt. (Programming note: Sosnick will be joining Yahoo Finance Live at 9 a.m. ET today.)

And the returns followed. The Nasdaq 100 — an index of the largest tech stocks — surged nearly 1,500% between its prior big bear market low on Nov. 20, 2008, and its most recent high on Nov. 19, 2021. The S&P 500, a larger, more diversified basket of stocks, rallied by 609% during its bull run from March 9, 2009 to Jan. 3, 2022.

The pandemic and ensuing inflation from fiscal stimulus and bottlenecked supply chains kickstarted the Fed's quest to raise interest rates, which flipped the prior decade's investing narrative. In 2022, the Nasdaq 100 fell 32%, its worst annual performance since the financial crisis.

Jefferies analyst Brent Thill has been examining the link between rates and software stocks, which he covers, in particular.

Thill sees a clear positive correlation between rates and energy shares and a negative correlation between rates and shares of software companies. In other words, low rates are good for tech and higher rates are good for energy. Which is exactly how 2022 played out for investors.

This chart shows what investors found out in 2022 — higher rates are bad for tech stocks and good for energy stocks. (Source: Jefferies)
This chart shows what investors found out in 2022 — higher rates are bad for tech stocks and good for energy stocks. (Source: Jefferies)

"I think the lingering problem here really is that higher rates must be discounted in the cash flow models used to value tech and aggressive growth stocks," said veteran tech investor Paul Meeks, portfolio manager at Independent Solutions Wealth Management. "If rates are high and stay higher, then valuations can’t expand significantly even when fundamentals improve."

Meeks also notes another phenomenon that accompanied low rates: private-market valuations ballooned as investors poured money into startups. This has also now reversed.

"Higher rates stop America's innovation engine because they'll continue to hinder venture capital and private equity and credit investments," Meeks argued.

This week, tech giants including Amazon (AMZN), Alphabet (GOOGL), and Apple (AAPL) are due to report quarterly results.

Apple CEO Tim Cook listens to US President Joe Biden deliver remarks on his economic plan at TSMC Semiconductor Manufacturing Facility in Phoenix, Arizona, on December 6, 2022. (Photo by Brendan SMIALOWSKI / AFP) (Photo by BRENDAN SMIALOWSKI/AFP via Getty Images)
Apple CEO Tim Cook listens to US President Joe Biden deliver remarks on his economic plan at TSMC Semiconductor Manufacturing Facility in Phoenix, Arizona, on December 6, 2022. (Photo by BRENDAN SMIALOWSKI/AFP via Getty Images) (BRENDAN SMIALOWSKI via Getty Images)

On Tesla's (TSLA) earnings call last week, CEO Elon Musk highlighted the effect on his vehicles' affordability given higher rates, saying "rising interest rates alone [effectively] increased the price of our cars in the U.S. by nearly 10%."

Investors will no doubt be looking for these companies' views on how interest rates have impacted their plans for future growth.

Though with Amazon and Alphabet already announcing job cuts in the tens of thousands, investors certainly have an idea.

What to Watch Today

Economy

  • 8:30 a.m. ET: Employment Cost Index, Q4 (1.1% expected, 1.2% during prior quarter)

  • 9:00 a.m. ET: FHFA Housing Pricing Index, November (-0.5% expected, 0.0% during prior month)

  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite, month-over-month, November (-0.65% expected, -0.52% during prior month)

  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite, year-over-year, November (6.70% expected, 8.64% during prior month)

  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller U.S. National Home Price Index, November (9.24% during prior month)

  • 9:45 a.m. ET: MNI Chicago PMI, January (45.1 expected, 44.9 during prior month, revised to 45.1)

  • 10:00 a.m. ET: Conference Board Consumer Confidence, January (109.0 expected, 108.3 during prior month)

  • 10:00 a.m. ET: Conference Board Present Situation, January (147.2 during prior month)

  • 10:00 a.m. ET: Conference Board Expectations, January (82.4 during prior month)

Earnings

  • Advanced Micro Devices (AMD), Amgen (AMGN), Boston Properties (BSX), Caterpillar (CAT), Exxon Mobil (XOM), General Motors (GM), Juniper Networks (JNPR), Marathon Petroleum (MPC), Match Group (MTCH), McDonald's (MCD), Mondelez International (MDLZ), NVR (NVR), Pfizer (PFE), Phillips 66 (PSX), Pitney Bowes (PBI), Snap (SNAP), Sysco (SYY), UPS (UPS)

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